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October, 2001
China update - October 2001
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Summary
1. Economic performance
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- GDP growth slowed to 7% in Q3 as compared to 7.9% in H1. The slowdown is largely attributed to a weakening of export growth, from 8.8% in H1 to 4% in Q3, which is in turn a result of worsened global economy.
- But domestic demand continued to defy global slowdown and maintained its growth momentum, with retail sales and investment growing by 9.7% and 14.8% in Q3 as compared to 10.3% and 15.1% in H1 respectively. Meanwhile the impact of export slowdown has also been offset to a certain extent by a 20% growth in FDI.
- Domestic demand hence sustained GDP growth at 7% for Q3 and 7.6% for Jan-Sep, which makes China's economy to stand out more strikingly as against other economies that have suffered a sharp slowdown.
- The global slowdown is set to accelerate in the months ahead, given the fallout of the Sep. 11th tragedy. This would inevitably further weaken China 's export growth, probably to a zero growth in Q4. But domestically another 15% salary increase starting from October plus the introduction of the 13th month salary issued at year-end is set to strength domestic consumption, while investment growth should remain strong.
- GDP growth is therefore expected to remain at above 7% in Q4, and to achieve 7.4% for 2001 as a whole.
- CPI inflation rose by 1% in Jan-Sep, lower than expected, reflecting both the importation of global deflation and domestic over-capacity. It is expected to stay at around 1% for the whole year.
- Rural income and non-state investment, two major constraints to economic growth at this stage, are improving, rising by about 5% and 8% in H1. But underlying weakness remains. The growth is still lower than that for urban income and state investment respectively, and also the sustainability of the growth is to be seen.
 
2. Economic management
| a) |
China's 15-year marathon bid to enter WTO has ended with all the negotiations and paperwork being completed. The entry will be formally approved by WTO at it ministerial meeting scheduled for 9-13 November 2001, and by China at its NPC annual session scheduled for March 2002. |
| b) |
Stock market reform is at the center of China's reform program at this stage, as the government intends to foster the stock market into a major platform for SOE reform and banking reform. The reform is currently focusing on cracking down on rampant stock market irregularities. This has however led to a serious correction in the stock market since late June. The market has also been hit by the Sep. 11th tragedy with sentiment effects. The government needs to be careful in balancing reform efforts and stock market stability. |
| c) |
There is no sign of change in the government's RMB policy. RMB's full convertibility remains a distant issue, despite the upcoming WTO entry. The widening of the RMB floating band is also still out of PBOC's agenda. Operationally RMB value continues to be delicately controlled so as to vary only at the third digit after decimal point. Anyway, given the continuous increase in foreign reserves and improving confidence on the economy, RMB continues to face no downward pressure. |
| d) |
RMB interest rates had been under upward pressure during the period of mid-1999 to mid-2001, with RMB rates staying below US rates while CPI inflation rising. We predicted in the last update that RMB rates would be increased if CPI rose to over 1.5%. But now that the direction of the rate differential has been reversed with consecutive US rate cuts while the CPI remaining below 1.5%, the prospect of a RMB rate increase has diminished in near future. A cut is not likely either, however, despite the prospect of further US rate cuts, given different cycles of the Chinese economy and the US economy. |
| e) |
Government bond issues have been kept within the target set early this year without additional bond issues so far. With the target, government deficit this year has the same size as last year. However, the deficit level, while being low in terms of the deficit as percentage of GDP (below 3%), is still rather high in terms of the deficit as percentage of government expenditure (about 13%). This would be a constraint to a prolonged proactive fiscal policy. |
 
3. External debt & reserves
| a) |
With FDI growing by 20.7% which has largely offset the impact of the reduction in trade surplus on the country's balance of payments, China's foreign exchange reserves continued to rise to USD195.6 bn at end-Sep. For the whole year, FDI growth is expected to maintain at 20%, while trade surplus likely to fall by about 25%. Hence there is no doubt that the figure will soon exceed USD200 bn, and is estimated at USD210 bn at end-2001. |
| b) |
Foreign borrowings in China have been moderate in past 3 years, first due to tightened control by SAFE after the Gitic event, and secondly owing to the lower RMB rates than US rates and a slow response by SOEs to the recent reversal of the direction of the rate differential. Thus foreign debt outstanding is currently well below the foreign reserves level. As SOEs wake up to respond to the reversal, foreign debt is likely to pick up pace. But it is not likely to exceed the foreign reserves level in near future. |
 
4. Structural factors
| a) |
Industrial profit growth has moderated with a 15.8% in Jan-Aug as compared to 25.4% in H1. The moderation is first due to the base effect given an 86% growth in 2000. But it also highlights the underlying problems of many SOEs remaining largely unresolved, that is the corporate governance problem and related problems of ownership, shareholder right, accountability and transparency, etc.. We expect to see intensified efforts in addressing these issues in next years when the stock market reform yields results and WTO opening-up advances. |
| b) |
Corporate governance is also the major issue for Chinese banks, and hence most of the major banks have been planning for IPO. But the plans have been discouraged by recent bearish performance of the stock markets, both overseas and domestic, and hence have been put off. The banking reform is currently focusing on reducing the NPL ratio by 3 percentage points per year for state banks in the next 3 years. |
| c) |
Preparations for WTO entry at central level are actually underway for two years since the signing of the Sino-US WTO agreement, with a large number of laws and regulations being amended to make them in compliance with the WTO requirements. But the preparations at local level vary with regions and companies. Many SOEs and local governments are not yet ready for the entry. |
| d) |
Investment to the West outgrew that to the East by 9 percentage points in Jan-Aug. But investment scale of the West is only 30% of that of the East. "Developing the West" must be a long-term strategy, and the coming 3-5 years would be the period for infrastructure development. A large scale of commercial investment, overseas or domestic, can only be expected after that. |
| e) |
Urbanization is another important development strategy. While a remarkable progress has been made in this regard in past two decades, intensified efforts are needed in view of both short-term social stability and long-term modernization of the country. |
5. Politics & social
| a) |
The brewing of the new leadership of the country is accelerating as the 16th Party Congress approaches. There have been no surprises so far, while some issues remain unclear. But anyway, the "Three Representatives" theory advocated by President Jiang Zemin will become the political guideline for the Party and the country going forward. The 6th Plenum of the 15th Party Congress held in Sep 2001 stressed the importance of the theory, while putting emphasis on the rectification of the Party's internal conduct and disciplines. |
| b) |
"Stepping down" has become a historical term in China, and the "stepped down" workers have now been categorized into the unemployed and covered by the country's social security system. This indicates the progress being achieved in the establishment of the social security system. Nevertheless, unemployment, particularly in the cities where large and traditional SOEs are concentrated, remains to be a big threat to social stability, and the development of the social security system needs to be stepped up given an inevitable further rise in the unemployment as WTO competition emerges. |
| c) |
Rural stability is also a concern which is related to a number of issues such as rural income, urbanization, rural migration and the development of the West, etc.. Efforts to address these problems are under way. But results need to be shown so as to prevent them from becoming a trigger for rural instability. |
| d) |
China has rendered its support, with common interests, to the War against Terror. Both President Bush and President Jiang Zemin expressed the willingness to establish a constructive and co-operative relationship between the two countries at the Shanghai APEC Summit just ended. This signals a fundamental change in the prospect of the future political Sino-US relationship, which was widely worried about just several months ago. Meanwhile, with China joining WTO and China's economy standing out more strikingly, economic ties between the two countries are expected to be upgraded to a new level in the coming years. |
| e) |
Taiwanese investors have rushed their investment into the mainland in the past year. Both authorities across the Strait have relaxed respective controls over the cross-Strait economic ties. Political relationship across the Strait, however, has shown little improvement. But with an improving Sino-US relationship, a serious deterioration in the relationship is not anticipated. |
 
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By Qun Liao
This memorandum is issued by Standard Chartered Bank and is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate of complete. Opinions expressed herein are subject to change without notice. This memorandum has been prepared solely for information purposes and for private circulation and no responsibility is accepted for the use or reliance on information herein. This memorandum does not constitute any solicitation to buy or sell any instrument or engage in any trading strategy. Standard Chartered Bank, or a company of the group of which it forms part, may have a position in any of the instruments or currencies mentioned in this memorandum.
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