China’s policy response

Capital Talk

THE Chinese government recognises the risks its economy is exposed to. Thus, it has been swift and aggressive in introducing measures to cushion it from being too seriously affected by the US-led financial crisis. iCapital lists the various policy measures below.

Monetary policy

The People’s Bank of China (PBC) started reversing its tight monetary policy in September 2008. The benchmark one-year lending rate was first lowered on Sept 16, 2008. Since then, PBC has cut interest rates another four times.

The one-year lending rate has been lowered by a total of 216 basis points over a period of four months to 5.31% currently.

This is the lowest level since February 2002. Although during the Great Asian Crisis, interest rates were slashed by a greater magnitude, it was done over a longer period of time.

This time, the speed of interest rate cuts was unprecedented. PBC also lowered the reserve requirement ratio (RRR) for financial institutions four times over the four months from September to December 2008, whereby the RRR for China’s big banks had been cut two percentage points, while for the small-and medium-sized deposit-taking financial institutions, the RRR had been slashed by 3.5 percentage points.

The target for monetary expansion has been set at 17% for 2009. PBC will stop issuing three-year bills and reduce the issuance of short-term paper for more liquidity to the financial system.

Fiscal policy

On Nov 10, 2008, China announced a historic 4 trillion renmimbi stimulus package, aimed at boosting domestic consumption and investment. At the same time, China’s various provincial governments have announced accompanying stimulus programmes amounting to about 10 trillion renmimbi.

Measures to boost the property sector

In addition to the 4 trillion renmimbi stimulus package to accelerate the construction of low-cost housing, below are other measures announced by the Chinese government to boost the property sector.

● Cutting the deed tax rate for first-time buyer of houses under 90 sq metres from 3.5% to 1%;

● Exempting stamp duty on property purchases;

● Exempting land value-added tax on property sales;

● Cutting the minimum down payment for first-time home buyers to 20% from 30%;

● Cutting the interest rate for personal housing provident fund loans from 4.32% to 4.05% for five-year loans. For loans above five years, the reduction was from 4.86% to 4.59%;

● Cutting the interest rate on mortgages to 70% of the benchmark lending rate and

● Allowing developers to form real-estate investment trusts to raise funds.

In addition, various local governments have announced their own preferential policies to stimulate the property sector in their respective areas.

Boosting the capital market

Below are the measures aimed at boosting the capital market:

● Proposing to launch a growth enterprise board;

● Encouraging insurance funds to increase their investment in the stock markets;

● Accelerating the deepening of the capital markets to increase the alternatives of financing;

● Tax exemption on interest received from individual securities transactions settlement accounts and

● Previously, both sellers and buyers were charged stamp duty on securities transactions. With effect from Sept 19, 2008, only sellers need to pay the stamp duty.

Other measures introduced in response to the US-led financial crisis turned economic crisis are:

● Abolishing loan quotas for commercial banks;

● Allowing commercial banks to lend for merger and acquisition activities of domestic companies;

● Encouraging insurance companies to expand their insurance coverage to a wider area of the economy;

● Encouraging insurance companies to invest in infrastructure for transportation, telecommunications, energy and in the rural areas;

● Postpone raising the minimum wage;

● Allowing some service-oriented companies to adopt flexible working hours and pay;

● Local governments taking steps to reduce wage in arrears and regulate staff layoffs;

● Including at least 50% of unemployed migrants who had been employed locally for more than six months in the urban registered unemployment statistics;

● Increasing government financial support to small and medium-sized enterprises (SMEs). This included an additional 1 billion renmimbi for the credit guarantee funds of the SMEs and preferential tax rates for the SMEs;

● Cutting the sales tax rate for vehicles with engine capacity of 1.6 litres or smaller to 5% from 10%;

● The government will offer 5 billion renmimbi in subsidies from March 2009 to encourage rural residents to replace old vehicles;

● Cutting the retail prices of gasoline and diesel;

● Raising export tax rebates;

● Increasing the flexibility of the renminbi’s exchange rate;

● Abolishing 100 government administrative fees and charges. This included various licensing fees, certification fees, examination fees, and other administrative fees;

● A four-year programme to encourage rural residents to purchase household electrical appliances; and

● A three-year programme costing 850 billion renmimbi to repair the nation’s healthcare system.

China’s economy expanded 9% in 2008. Some economists have forecast that China’s economy will experience a hard landing in 2009. iCapital thinks that China’s economy will grow 6.5%-8% in 2009.

The positive factors below are expected to see China through the world economic downturn in 2009.

First, China observes a unique economic system, whereby the forces of free market and government controls go hand in hand. The fact that the government still has control over the workings of the economy will ensure that the various policy measures listed above will be able to impact the real economy at a faster pace.

Recent data show that some of the stimulus measures are already working. In the event that more measures are needed going forward, China’s one-party system will facilitate a swift policy response.

Second, China’s economy was in a strong position when the US-led financial crisis erupted. The situation was somewhat similar to the experience during the Great Asian Crisis. Solid economic fundamentals allow the Chinese government to make swift and flexible policy responses.

This is critical in preventing a looming crisis from spinning out of control. Hence, China’s economy should be able to ride out the financial storms relatively unscathed, as it did during the Great Asian Crisis.

Third, the sharp fall in industrial output in the last few months reflected mainly inventory liquidation. This process is expected to be completed by April 2009, and hence will lead to a revival in production activity.

Fourth, improving the agriculture sector and the rural areas has been top priorities for the Chinese government. This is consistent with China’s long-term goal of narrowing the rural-urban income gap and maintaining adequate supply of affordable food.

Fifth, China has a huge domestic market. China’s GDP per capita has been rising rapidly in the past few years, surpassing US$3,000 in 2007.

China’s savings rate was close to 50% in the last three years. This, coupled with the efforts made in improving the social safety net, will help to ensure a relatively stable private consumption.

That said, iCapital is of the view that although China’s economic growth in 2009 may fall below 8% and the unemployment rate may climb to the highest level since the early days of economic reforms, the lull is likely to be short-lived and hence would not affect the social stability of China.

Furthermore, as China has been experiencing rising urban unemployment rate for years, it will not be caught unprepared.