China and the effects of the Asian financial crisis

By Ding Qilin

The financial crisis sweeping much of Asia has crippled once- proud economies in the region and toppled a president, and it shows no signs of abating. Amid the turmoil, China seems to be the last bulwark against further collapse of economies in Asia. The Chinese government has vowed time and again that it will not devalue the Chinese yuan and that the country has the capability to achieve an economic growth rate of 8 percent for 1998.

Of course, there are doubters. Some economists believe that China will not be able to achieve its economic development goal, and they say that the Chinese government will eventually be forced to devalue the yuan under pressure from the Asian crisis.

Chinese economists have said the crisis is not having much of a DIRECT impact on the Chinese economy. One reason is that the Chinese yuan is convertible only under the current account, not under the capital account, and the country has enjoyed a favorable foreign exchange balance. The country has fairly large foreign exchange reserves, which reached US$140.6 billion at the end of March, 1998.

As for the capital market, China has limited foreign capital to investing in Chinese firms that are listed overseas or to buying B shares within China (versus A shares that are available to Chinese citizens but are off-limits to foreigners). The country prohibits foreign investors from purchasing domestic bonds. These measures act like a barrier between Chinese and foreign capital markets, allowing the former to remain stable amid the regional turmoil.

Chinese economists pointed out, however, that indirect effects of the crisis on China's economy should not be overlooked. China, as a result of its bold reform and opening during the last two decades, has developed into a sizable economy which is far more integrated with the global economy than ever before.

Statistics show that, while in 1978 the Chinese economy had a dependence rate of 9.8 percent on exchanges with the rest of the world, by 1996, that rate reached 35.6 percent.

"These statistics demonstrate that China now plays a far more important role in the world economy than every before," said Li Shantong, a senior researcher with the Development Research Center under the State Council, the central government. "And it follows that the country is now far more sensitive to repercussions from the global economy."

Destinations of Chinese exports are mainly Asia, North America and Europe. In 1997, China exported $108.9 billion worth of goods to the rest of Asia, 59.6 percent of its total exports; $34.6 billion to North America, 18.9 percent; and $29 billion to Europe, 15.9 percent of the total. Owing to currency devaluations in Southeast Asian countries, Chinese exports there this year have gone up in price and decreased in volume by varying degrees.

"Even so, China is capable of tackling this tough situation by adopting various measures," said Liu Xiangdong, a vice minister of foreign trade and economic cooperation.

China is deepening reform of its foreign trade sector. Management is being improved, while mergers to achieve economies of scale are being promoted, Liu said. The government has also raised refund rates for a host of export goods to boost export competitiveness.

"The Asian financial crisis has made it imperative for China to diversify its export goods markets to ensure a satisfactory volume of foreign trade and financial stability," Liu said.

Chinese exports to Japan and other Asian countries have indeed declined, while Chinese exports to Europe and the United States have picked up. In the first five months of 1998, Chinese exports to Japan were worth $11.31 billion, down 5.7 percent from the same previous period. During the same January-May period, China's exports to the United States reached $13.34 billion, up 18.1 percent, and its exports to the European Union were worth $10.68 billion, up 25.5 percent.

According to the State Statistical Bureau, China had a favorable trade balance of $22.6 billion in the first half of 1998.

China will continue its policy of opening up markets in developed countries, expanding its market share in developing countries and maintaining its market shares in the rest of Asia with flexible measures, according to the vice minister.

"We will also adjust our product mix in accordance with consumer demand in different countries and regions," Liu said. "In particular, we'll try hard to open up new markets with goods of high quality -- products with high-technology features and therefore high added values."

According to Li Shantong of the Development Research Center under the State Council, China is not overly dependent on exports for economic growth, considering its enormous size.

In Li's opinion, China, with its 1.2 billion population, is in itself a huge market. "It is clear that China can achieve sustained economic growth by stimulating domestic demand," she said.

According to a study by the research center that has looked at factors contributing to economic growth in China since 1978 when reforms were launched, spending on capital construction projects has played the most important role in promoting economic growth. It is calculated that 50 percent of China's GDP growth in the period has been contributed by capital spending, the study reports.

In the last few years, the Chinese government has successfully brought an overheated economy to a soft landing, by mainly cutting down on investment in fixed assets, or capital spending. But in its zeal to contain inflation, the government may have overshot the mark. Consequently, since the beginning of this year, consumer demand has been sluggish despite price cuts -- the country now has a negative inflation. This, coupled with the effects of the Asian financial crisis, threatens to slow down the country's economic growth.

Overseas investment in China is also being affected. By last October, Asia's financial turbulence started to affect Hong Kong, a major investment source for the Chinese mainland.

"Given the situation, expanding domestic demand has become a must," said Wu Jinglian, a senior researcher with the Development Research Center of the State Council.

The Chinese government has been quick to react to the Asian crisis to ensure an 8 percent economic growth for this year. Spending has increased dramatically on infrastructure projects, such as railways, highways, power stations and agricultural facilities. In highway construction, total investment in construction has increased from a planned 120 billion yuan ($14.45 billion) to 160 billion yuan. Investment in railway construction has also been increased by 16 percent on the original budget.

Spending on capital construction projects will create jobs for laid-off workers and stimulate consumer demand, thereby fueling economic growth, said economists.

According to past experience, an over-rapid increase in investment causes redundant construction and rash investment decisions -- and money losses. This time around, the government said increased investment should be directed mainly into infrastructure and agriculture, areas where improvement is most needed.

The latest measure to stimulate consumer demand has been taken by the People's Bank of China, the central bank, which announced a cut in interest rates for bank deposits and loans. It is the fourth such cut in the past year.

China's economic growth in the first half of 1998 stood at 7 percent, according to the State Statistical Bureau. But this has not diminished the hope of the 8 percent growth target for the year held by the government and most economists.

According to Liu Guoguang, a vice president of the Chinese Academy of Social Sciences, measures designed to stimulate the economy are beginning to play their role in the second half of the year.

"Vital sectors of the Chinese economy -- transportation, energy, raw material supplies and agriculture -- are at present in the best of condition, and the country's foreign exchange reserve is at its highest level in history," Liu said at a June international symposium in Beijing. "These can fully support an economic growth rate of over 8 percent."

China is a relatively poor country, its per capita GDP is about $750. However, rapid economic development in the past two decades has boosted its economic strength. In 1997, China ranked seventh in the world in terms of GDP size, and it is the second- biggest recipient of international investment after the United States.

Against this background, and in the face of mounting pressure, Chinese leaders have repeatedly stated that China will not devalue its yuan in a bid to help stabilize the Asian economy.

The crisis "has elevated the status and role of China," states an annual outlook report by the Singapore-based Pacific Economic Cooperation Council. If China should devalue its currency, "it would likely start another round of competitive depreciations" in the Asian region, the report states.

Said a high-ranking official of the People's Bank of China: "If some kind of depreciation should occur in China, the Chinese people would lose their trust in their country's financial system."

"In the long run, devaluing the yuan would not only be disastrous for Asia but would also hinder the development of China's own economy," he said.

Said Li Shantong: "China is a responsible country. It will keep its currency stable for the sake of China's own benefit, the Asian economies and the world economy as a whole."