Effect passes the United States. Chinese exports

Effect of 2008 crisis on chinaChinese
economy has emerged as a major player in the world economy. Chinese economy’s
high GDP growth has changed the distribution of economic activities across the
world. It passed Japan to become the second largest economy, and it is only a
matter of time before it passes the United States. Chinese exports have lessened
consumer prices around the globe, and its imports have begun to have a major
impact on global commodity prices. China has become a major in intra-industry
trade. From this point of view, China may become one of the engine of the world
economy. What
is of most importance is to know how China responded to the global economy,
especially the global financial crisis and with concerns regarding US recession.
The report provides a brief review of China’s economic position in the world
economy, discusses the spillover effects of the global financial crisis on
China’s financial markets and the real economy, and analyzes the reasons for
the limited impact of the global crisis on China. One interesting result is
that while China was not one of the countries strongest hit by the crisis,
neither was it as insulated as is assumed. Although its high growth rate during
the crisis was the envy of most of the other countries, Chinese growth was
substantially lessened by the crisis, suggesting that the decoupling of Chinese
growth from the advanced countries may not be as great as many popular analyses
have suggested. This report also talks of the major challenges facing China for
a sustainable growth. Spillover
Effects of the Global Financial Crisis on China’s Economy The
subprime financial crisis of the US released a series of serious effects from
the stock market collapsing, financial institutions failing, and economies being
pushed in recession. This crisis spread from real estate to other sectors of
economy and across the globe leads to the global financial crisis. Since, China
was able to maintain relatively high economic growth, the negative effects from
the global financial crisis on China were considerably stronger than is often
realized. This misconception arose largely because China continued to have one
of the highest rates of economic growth all across the globe, recording 9.6% in
2008 and 9.2% in 2009 (Table 1). What is missed here is that, while most
countries would be delighted to have such growth, these rates reflected a
substantial drop from the 14.2% growth in 2007. In terms of the falls in growth
rate during the crisis period, China was hit as hard as many of the advanced
economies.The
crisis spread by a number of channels. For the initial stages, financial
channels were the important ones. Financial institutions of a number of
countries, especially in Europe, had invested heavily in securities linked to
the US real estate market. These investors had suffered huge losses. The
investors generated a general flight to safety which led to large capital
outflows from most emerging market economies that had few direct linkages with
the US real estate market. China remained to be largely immune to these wealth
and capital flow effects. FDI in China decreased during the beginning of
financial crisis and rebounded to almost the pre-crisis level later on. As
shown in Table 2, China’s net FDI decreased to $121.68 billion and $70.32
billion in 2008 and 2009, dropping 15% and 42% year by year, respectively, and
increased to $124.93 billion in 2010.But,
there was also a global financial impact that did not operate directly through
capital flows. This crisis affected the economic outlook and risk attitudes
across the globe and China was not immune. Before the crisis, extreme optimism
had affected many a markets across globe and China’s stock market was no
exception. Like in many other countries, China had enjoyed a stock market boom,
increasing fivefold between 2005 and 2007. Such rapid growth made markets
highly likely to suffer major reversals, and this is just what occurred when
bad news hit.With
onset of October 2007, the stock market in China crashed, wiping out more than
two-thirds of its market value. A similar story applied to the real estate
market. A bubble had started to grow with China’s booming economy, since most
of the people believe that investing in property, such as real estate, is safer
than putting money in the banks. These impacts of developments on the Chinese
economy were relatively small compared with the trade channel, however.In
its early stages, the magnitude of the crisis was substantially underestimated
by most governments and private sector analysts. The adverse effects on the
real economies were expected to be quite limited. Hence, it was believed that
most emerging market economies would be little affected. This gave bit boost to
arguments that the behavior of emerging economy financial markets was
decoupling from those of the advanced economies. But, as the crisis began to
push the US and Europe into recession, the trade channel came to the front. This
falling demand in advanced economies had a huge impact on their demand for
imports from each other and from emerging markets. With its past rapid growth
in exports, China was especially exposed to the falls in global demand for its
exports.By
November 2008, China’s export growth rate fell sharply to ?2.2% from 20% in
October. As a whole, China’s exports fell by about 17% in 2009, before
recovering to positive growth in 2010, as the advanced countries began to grow
again (Figure 1). The rebounds of economic growth in advanced countries have
had been modest, and this has limited the size of the rebound in China’s
exports. Although China’s export business has leveled off, development of the
domestic market helped maintain China’s sustainable economic growth over the
long term.How Did China Maintain a High Growth
Rate during the Crisis?Strong Fiscal PositionThe
main factor in China’s high growth rate was its ability to quickly adopt a
strong stimulus package. Which was feasible because of China’s strong financial
position.In
Asian crisis of 1997-98, the crisis hit countries had weak financial sectors
and low level of international reserves which sharply lowered their ability to
adopt stimulus policies in the fare of their recessions. The countries learned
a great deal from the crisis and substantially strengthened their financial
systems and built up high levels of international reserves. Combined with sound
fiscal positions, as this gave many Asian economies considerable monetary and
fiscal space to adopt substantial stimulus packages to help offset much of the
decline in their exports. China is a prime example of this phenomenon showing
this.Because
of its strong position, China could afford to generate considerable fiscal and
credit expansion. Over the past decade, China’s budget deficits as percentage
of GDP have been very low, laying less than 3 percent since 2000. In 2007,
China even had a budget surfeit. Even in the face of the huge stimulus package
launched after the beginning of the financial crisis, the 2008 and 2009 deficit
to GDP ratios were still just 0.4 and 2.2 percent respectively, which was far lesser
than most advanced countries.When
the crisis hit, the Chinese government took rapid correctives to reduce the
impact of the global financial crisis. From the third quarter of 2008, the
Chinese authorities adopted a mash-up of an active fiscal policy and a loose
monetary policy by instigating an RMB 4 trillion ($580 billion) stimulus
package for 2009 and 2010 in November 2008. Those efforts to support the
economy during the global financial crisis induced a flow in bank lending. Bank
lending in China summed RMB 9.6 trillion in 2009, reaching nearly half of that
year’s GDP. Substantial funds from bank lending was channeled into the nation’s
stock and property markets rather than real economic activities, which
contributed to the limited recovery of China’s stock markets from the lows
reached in early 2009. Even with adopting the expansionary fiscal policy,
China’s debt-to-GDP ratio was still less than 20 percent at the end of 2009. In
2010, the Chinese central government budget deficit remained only 1.7 percent
of GDP, as compared with 8.9 percent in the United States. These expansive
policies had a major impact on the extent of the drop in growth.A High Level of Foreign Exchange
ReservesOf
the emerging market economies, mostly expansionary monetary and fiscal policies
regularly generate large balance of payments deficits which threaten confidence
in their exchange rates and guzzle international reserves with low levels, so
the viability of large stimulus policies can be highly restricted. High reserve
levels on the other hand make substantial stimulus packages much more reasonable.
From this perspective China was in an awfully secure position.In the
first quarter of 2011, China held foreign exchange reserves of about $3
trillion, the highest level in the world and three times that of the next
largest holder, Japan. As international reserves and external borrowing are substitute
ways of financing government spending in the face of sovereign risk. China
could take benefit of its strong reserve position by adopting a large
stimulates package without having a need to worry about its high borrowing
costs to fund its government spending, or generating a balance of payment
crisis.Limited International Capital FlowSince
entry of WTO in 2001, China’s controls over foreign banks and international
capital flows have been lessened. While China has been gradually loosening its
control on international financial flows, the regime is still quite confining.
Despite much discussion of the various ways of evading these controls, they
still have enough effectiveness to strongly limit international financial
flows. Most economists would argue here that such controls carry efficiency
costs, which can limit a country’s exposure to international financial
instability.Most
financing for development in China continues to be from domestic sources. For
example, at the end of March 2008 the total assets of foreign-funded banks in
mainland China was around $193 billion, accounting for only roughly 2.4 percent
of total bank assets in China. Thus, foreign-funded banks remain too small to
play an influential role in the financial system.Additionaly,
China has only slowly pursued liberalization of its domestic financial sector,
and there has not been a great deal of financial innovations such as
Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDO).
Between 2007 to 2009, the total losses in China’s financial system compared to China’s
precrisis GDP were limited to just over 2%.China’s Major ChallengesRebalancing the EconomyIn
spite of the enormous success, China’s export led growth is not a viable
long-run strategy. There is a great deal of consensus including within the
Chinese government that a substantial rebalance of the economy was of need.
Domestic consumption remained at an extremely low proportion of the economy,
while exports dependence were too high. For example, in 2007, earnings from
exports accounted for 37% of China’s GDP.Similarly,
serious questions have been raised about the efficiency of the extremely high
levels of investment. Such rebalancing will provide a more sustainable domestic
growth strategy and help with reducing global economic imbalances and reduce
the treat that importing countries will take protectionist measures against
China’s exports.While
there had been broad agreement on the objectives of rebalancing, progress has
been low and faced considerable obstacles. Reducing over investment might have
faced substantial political opposition from those who have been gaining from
their investment. Increasing domestic consumption relative to saving was also
difficult since it will required a substantial expansion of the social safety
net in order to reduce the incentive for precautionary savings.While
most economists believe that substantial appreciation of the RMB would help
rebalancing as well as reducing inflationary pressures, the short-run
dislocations that this would cause also generates political opposition.Inflationary Pressures and Price Bubbles
in the Real Estate SectorAlthough
the Chinese stimulus program was reasonably successful in reducing the size of
the slowdown in economic growth, it still carried side effects in terms of
increasing inflation and contributing to what can be seen as a real estate
bubble.The
aim behind the stimulus program was to help increase consumption and business
investment. But a large proportion of the resulting credit expansion flowed
into the stock and real estate markets and Inflation became one of the important
challenges in China. Especially as sharp price bubbles appeared in the real
estate sector. For example, by estimates, the average price of an apartment in
Beijing has risen between 5-10 times in the past decade. Thus, China came at
risk of a bursting asset price bubble, which would damage its banking sector
and credit system even more severely than the 2008-2009 crash.The
increases in the general price indices also started to rise soon after the
stimulus package was implemented. It thus started showing signs of a short-run
Philips curve where rapid expansions of aggregate demand tend to increase both
economic growth and inflation. The CPI in China has been increasing, since
2009, reaching around 5.5 percentages in October 2011 which is higher than the
average inflation rate of 4.25 percentages from 1994 until 2010. These
inflationary concerns in turn stimulated the most recent tightening of monetary
policy.Nonperforming Bank LoansNonperforming
bank loans have been a problem for some time, and the rapid expansion of credit
during the stimulus program has brought this problem to the fore again.With
China central government debt being so low (about 20 percentages of GDP) and
foreign reserves so high, the government has been able to afford to bail out
banks. China has also recapitalized banks several times after periods of
economic stress and to prepare them for WTO entry and eventual foreign
competition. China, in 1998, issued $33 billion worth of special government
bonds to recapitalize the four major state-owned banks viz. Bank of China, China
Construction Bank, Agricultural Bank of China, and the Industrial and
Commercial Bank of China, all of which were technically insolvent. China, in
1999, created 4 asset management companies that bought $170 billion of bad
loans from these four biggest state-owned banks at face value. In 2005-06, further
capital infusions were undertaken in advance of the initial public offerings
(IPOs) of Bank of China, China Construction Bank, and the Industrial and
Commercial Bank of China, while a further $US 19 billion capital injection in
Nov 2008 helped pave the way for Agricultural Bank of China’s belated July 2010
IPO. Recently in 2010, the government again recapitalized the state-owned banks
with an estimated $56 billion. Most of the Chinese banks remained dominated by
the government, banks will not refuse to offer new loans if the authorities
demand that they do so, even as old loans sour. New lending by banks was
equivalent to 31 percentages and 21 percentages of GDP in 2009 and 2010,
respectively, and 39 percentages and 34 percentages of GDP if off-balance-sheet
lending is factored in. Over just the first eight months of 2011, Chinese banks
reported about $60 billion in new nonperforming loans. Among 14 large
commercial banks, more than half reported an increase in nonperforming loans
(NPL) in excess of 10 percentages since June 2010 and private estimates are
usually much higher than official ones.By
March 2011, China’s credit-to-GDP ratio had already risen to 166 percentages as
compared to 120 percentages at the end of 2008. As Credit Suisse Group AG
suggested when it announced that it was cutting Chinese bank’s rating in June
2011, China’s credit “has risen to alarming levels in the past two years due to
massive off-balance-sheet financing, and raised a red flag for future asset
quality problems in banks”.Other ProblemsChina,
of course, faced a number of other economic problems too. As the global crisis
has clearly illustrated the importance of having adequate levels of
international reserves, China has had accumulated more reserves than are needed
for their purpose. These excess reserves are as always are an inefficient use
of scared national resources. There reserve holdings are more heavily
concentrated in dollars than is desirable on grounds of portfolio
diversification. Handling these issues will not be easy as reducing the level
of reserves would require substantial adjustments in the balance of payments
and rapid reserve diversification would run the risk of generating a dollar
crisis.Another
concern was how to combine continued rapid economic growth while taking actions
to deal with a wide range of environmental issues. Additionally, ways must be
found to continue to promote growth without continuing large increases in
income inequality amongst both individuals and regions.How
best to continue financial reforms is one another difficult issue? The global
crisis has painfully illustrated the dangers of inadequate supervision of the
financial sector, but the current financial systems in China create a number of
serious distortions. Thus, further financial liberalization needs to be pursued
and has to be done in a very careful manner.BibliographyChina Economy. (2011). Retrieved from CIA World Fact Book:
http://www.photius.com/rankings/economy/imports_2011_0.htmlChinese GDP Share of the World’s Total
Jumps to 9.5 Pct: NBS.
(2011). Retrieved from
http://news.xinhuanet.com/english2010/china/2011-03/24/c_13796714.htm,
http://www.xinhuanet.com/Fear of the Dragon—China’s Share of World
Markets Increased During the Recession. (2010). Retrieved from Economist:
http://www.economist.com/node/15213305