14-NOV-08: Details to the fiscal package in China

A press conference held today by the State Council Information Office shed some light on the details of the fiscal stimulus package announced on 09 November 2008. Media representatives were told that the RMB 4 trillion package over the next two years does include additional-to-plan expenditures, but the exact figures of “new money” were not provided. It was made clear that total government investment over the next two years will be higher than the RMB 4 trillion announced. As for the origin of the funds, RMB 1.18 trillion are to be supplied by the central government and RMB 100 million come from the NDRC budget. There was no mentioning of exchange reserves to be used to finance domestic investment, as some observers suspected. It was, however, mentioned that foreign exchange reserves will be continued to be used for international investments in a “responsible manner” and that this would contribute to overall stability.

Surprise fiscal package in China

Fighting inflation is a thing of the past in China. Yesterday, the state council approved and published its plan to spend a total of RMB 4 trillion, almost USD 600 billion in the next two years to fight the negative impacts of the financial crisis (China Daily, 09-Nov-2008). The fiscal stimulus is set to be acompanied by appropriate “moderately active” monetary policies. This annocuncment formally ends the “tight” (monetary) policy stance adopted in the wake of overheating and inflationary pressures in the last year-and-a-half or so.

The fiscal stimulus concentrates on a dozen main areas, from low-income housing and rural infrastructure to the environment and technological innovation. Special focus will be on the earthquake areas affected in May this year. The program incorporates expenditure and revenue-based measures, the latter mainly in the form of a comprehensive reform in value-added taxes. The package also includes the abolishment of commercial banks’ credit ceilings to channel credits to priority projects.

It is widely discussed that the government wants to avoid at any cost that GDP growth may slow below the 8 per cent threshold; this is the rate of growth – widely believed in China – needed to absorb the new entrants into the job market every year (i.e. around 20 million people). It is clear that the package shall shelter the Chinese real economy from global downturn, but a series of questions remain open to understand its impact: Are the RMB 4 trillion additional expenditures to the already planned fiscal activities or does it embrace all fiscal expenditures for the  next two years? How is the package funded? Is it really feasible to further boost infrastructure building by such large margins knowing that construction already expanded strongly during at least a decade? For all the open questions, the government most likely just wants to set an example at this stage (NZZ, 10-Nov-2008).

18-JUN-2008: UNCTAD Discussion Paper published on “Instruments of monetary policy in China and their effectiveness: 1994–2006″

The United Nations Conference on Trade and Development (UNCTAD) published the long-awaited paper on “Instruments of monetary policy in China and their effectiveness: 1994–2006” in its Discussion Paper Series. The paper argues: “China’s monetary policy applies to two sets of monetary policy instruments: (i) instruments of the Central Bank (CB), the People’s Bank of China (PBC); and (ii) non-central bank (NCB) policy instruments. Additionally, the PBC’s instruments include: (i) price-based indirect; and (ii) quantity-based direct instruments. The simultaneous usage of these instruments leads to various distortions that ultimately prevent the interest rate channel of monetary transmission from functioning. Moreover, the strong influences of quantity-based direct instruments and non-central bank policy instruments bring into question the approach of indirect monetary policy in general.” The paper – among others – builds the basis of this blog.

Earthquake in China: Mainly local impact on the economy

Last week saw further discussions among economists on the proper monetary and macroeconomic policy response to the earthquake of 12 May as well as about the questions whether it bears an impact on the overall economy in China. As suggested in my earlier post on the earthquake, there is consensus that short-term and local emergency relief is to be granted, while not loosing sight of the overall economic need to tightening monetary policy. The PBC confirmed this approach when Zhou Xiaochuan, the governor, said in a press briefing in Chongqing that it is necessary to meet the demand by enterprises in the affected area, by ascertaining the implementation of macro-control measures (既要满足抗震救灾企业需求，也要落实好宏观调控举措).

This balancing approach is facilitated by a series of reports and high-level assessments that the impact of the quake is mainly local and does not substantially affect the overall economy. People’s Daily refereed to Ba Shuosong, a senior and well-known expert at the State Council Development and Research Center, and headlined on 26 May: “Earthquake not to affect the fundamentals of China’s economy“. Similar articles were published by China Daily on 29 May (“Quake ‘will not affect nation’s growth’“) and Xinhua on 13 May (“Earthquake won’t have major impact on China’s economy“).

Counting the economic cost of the earthquake for China’s economy at large, however, may have at least one casualty: The inflation rate. This is since Sichuan Province is an important supplier of grain and pork, both of which already feature prominently as a driving force of current CPI inflation. Just how much this will matter and over what time horizon is unclear at the moment. Nevertheless, forecasts suggest a slight easing off of national inflation in the second half of the year.

Earthquake response in China: The role of monetary policy

While the clean-up operations are in full progress after the terrible earthquake on 12 May 2008, economists are discussing the scope to support the quake areas and the overall effects on the Chinese economy. Short-term emergency relief through monetary policy should certainly be granted, but against the background of a nationwide inflation of over 8 per cent in the last four months, the overall focus of monetary authorities needs to stay on a tightening stance.

This seems what the authorities are doing. In the last two weeks the measures with the biggest headlines included:

Minimum reserves: Effectively 20 May, the PBC raised the reserve requirement ration to 16.5 per cent. To support the affected areas six cities were exempted from the rate increase, namely Chengdu, Mianyang, Deyang, Guangyuan, Yaan and Aba.

Window guidance: A joint notice given by the PBC and the China Banking Regulatory Commission (CBRC) asked commercial banks to provide extra loans to the areas affected by the earthquake. It was added that individuals who miss their loan payments due to the earthquake should not be subject to usual penalties.

Additional refinancing: The PBC agreed to give extra refinancing means to commercial banks in the quake-hit areas. So far, an extra of RMB 5.5 billion was centrally granted to Sichuan and Gansu Provinces. Additionally, the Chengdu branch of the PBC granted an extra RMB 2 billion to local lenders and communes.

Price controls: “China will intervene temporarily to control prices of steel products, cement and other building materials in the earthquake disaster zone, the central government’s economic planning agency said.”

The overall macroeconomic effects of the earthquake seem modest, due to the mainly local character of heavy devastation around the epicenter. Moreover, Sichuan’s provincial GDP has a minor share in China’s overall GDP only, due to it’s agricultural focus of economic activity. In turn however, this and complicated transport due to destroyed infrastructure may have an impact on rising food prices and thus inflation. Just how much this will matter is unclear and this certainly makes the PBC’s fight against inflation at large more difficult, particularly in the short-term.

China’s bank profits: What a wonderful Q1 2008 result!?

In the last weeks, China’s banks published their profits for the first quarter 2008. Double digit growth rates were the norm and three digit growths were not rare: Net profits of mid-sized commercial banks such as the Bank of Beijing and the Shanghai Pudong Development Bank reportedly increased by whopping 150 per cent each in Q1 2008 (compared with Q1 2007): Of the “Big Four”, Bank of China (BOC) reported 85 per cent, Industrial and Commercial Bank of China (ICBC) 77 per cent and Agricultural Bank of China (ABC) 71 per cent of profit growth. The major parts of the profits came from interest rate income.

In a simplified fashion, one can say that interest rate income is the difference between the income generated through lending operations and the interest paid to customers for their deposits at a bank. This difference widened considerably through the recent efforts to curb inflation and the increases in the benchmark one-year lending rate to currently 7.47 per cent. This is contrasted by a 4.14 per cent deposit rate, leaving an interest rate spread of 333 basis points (see Stats Update).

In a short note from Thomson Reuters on 10 May this spread was analyzed. It was rightly concluded that this relatively high gap between lending and deposit rates gives a big incentives to banks to ever-increasing their lending operations. This tendency to increase lending from the supply side is reinforced by negative real interest rates for the customers on the other side that leads to higher demand for bank lending in general (for an analysis of the problem of negative interest rates in China and other emerging economies please refer to The Economist, 8 May 2008: “Economics focus – A tale of two worlds”). This is no good news for fighting inflation.

Non-performing loans in China: China Banking Regulatory Commission released 2007 statistics

Recent developments: China Banking Regulatory Commission (CBRC) at the beginning of May released its statistics on non-performing loans (NPLs) as of the end of 2007. For the banking system as a whole the NPL share stood at 6.17 per cent, reportedly the lowest level ever recorded and down around 1 per cent from the 2006 level. This is good news, as lower NPL ratios mean a healthier banking system at large that is in turn better able to transmit monetary impulses of the central bank. Additionally, at the background of the current credit crisis lower NPL ratios means even better news. However, developments of NPL ratios in China need to be handled with care, as the background below lays out.

Background: While there were problems with non-performing loans in China during the time of the planned economy, the problem was kept undiscovered due to the almighty allocative role of the state. Once the reforms started in the late 1970s, the issue was not immediately on the agenda. It took more than a decade until the problem was discovered and publicly discussed in 1993, when the thinking of a commercial bank law evolved. It reached the top of the agenda in 1997, when the Asian financial crisis showcased the importance of a well-functioning and healthy financial sector (Lou, 2001: 3ff). For the 1990s, various estimations exist on the scope of the NPL ratio of the total banking system. They vary between 10 per cent and 60 per cent, with Chinese sources being at the lower and foreign sources at the higher end of estimations (cf. EIU, 1998a: 18; EIU, 2000a: 7; and Lou, 2001: 14). The reason for the difference of Chinese and foreign sources is in the Chinese loan classification system before 1998. For instance, Chinese accounting standards viewed interest income on overdue loans as generated income even if no interest was received. However, the classification differences have gradually been diminished since 1999, when the PBC announced a new system (EIU, 2003a: 14). With the new classification system in place, NPL ratios from Chinese and foreign sources gradually leveled off. Thus, from 2001 onwards domestic and foreign estimates show rather parallel developments for the Big Four commercial banks.

Undoubtedly, there were huge improvements in the NPL ratios of the “Big Four Commercial Banks (Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial and Commercial Bank of China) since 2001. However, these figures have to be treated with care since strong improvements in the capital adequacy and non-performing loan ratios of BOC, CCB and ICBC in 2004 came not as a surprise. Their timing was determined by the government’s wish of listing state-owned commercial banks on international stock exchanges to prepare them for the opening up of the financial system. This was scheduled for the end of 2006 along China’s commitments of the WTO entry. Accordingly, CCB went public in Hong Kong in October 2005 followed by BOC in June and the ICBC in October 2006. Thus, the performance increase was mainly the result of a political-driven process triggered by injections of foreign exchange reserves, the issuance of subordinated debts and the transfer of bad loans rather than the result of a better bank management. On top of that, there is a tendency that due to rising amounts of total outstanding loans for the banking system at large, NPL ratios decline even though the total amount of NPLs increased (EIU, 2005a: 13).

Specific references

EIU (1998a). China Hand, Chapter 3: Finance. Economist Intelligence Unit, March, Hong Kong.

EIU (2000a). China Hand, Chapter 2: Finance. Economist Intelligence Unit, February, Hong Kong.

EIU (2003a). China Hand, Chapter 3: Finance. Economist Intelligence Unit, March, Hong Kong.

EIU (2005a). China Hand, Chapter 3: Finance. Economist Intelligence Unit, March, Hong Kong.

Lou Jianbou (2001).China’s Troubled Bank Loans: Workout and Prevention. International Banking, Finance and Economic Law, Kluwer Law International, London The Hague Boston.

Snow in China: Complicating macroeconomic control in the short-term

Economists are widely discussing the economic effects of the worst winter storms in decades in China. Obviously, there are a certain immediate effects such as difficulties for transport, power and water shortages and resulting production shortfalls. Direct economic losses were estimated at USD 7.5 billion as of 1 February 2008. These may raise as bad weather is thought to persist for another week or so. Overall, however, these effects will mainly be temporary.

The macroeconomic consequences will depend on how the authorities will react in view of these burdens. To counter the direct effects some speculate that China may refrain from tightening policies due to the weather conditions. In fact, the PBC already started to selectively loosen its policies by ordering local commercial banks to grant extra loans in areas affected by the bad winter weather (11 provinces are mentioned: Hubei, Hunan, Guizhou, Anhui, Jiangxi, Jiangsu, Zhejiang, Henan, Shanxi, Guangxi, and Chongqing). As one economist put it: “[The order] effectively announced that the credit tightening since end-October 2007 is temporarily over for many sectors” (Merrill Lynch economist Ting Lu).

Such policies pose a great threat as already rising prices in a strongly growing economy will be further fueled through both shortages caused by bad weather and failure to provide anyhow necessary tightening. Anecdotic evidence already shows that fresh vegetables start to disappear from supermarket shelves in some areas and what remains is sold at high prices. Against the background of the overall expansionary economic situation – while emergency relief certainly is to be granted – the focus of the monetary authorities should stay on a tightening stance. All the more so since the direct economic impact associated with the bad weather mainly is of short-term nature.