By Yu Bin & Zhang Liqun

Since the beginning of this year, the Chinese economy has maintained a steady growth momentum despite a marked slowdown in the world economy. The growth of domestic investment demand has been strong, the growth of consumer demand has been steady, the structure of supply has improved, and the quality and efficiency of economic operation have been improved further. Economic growth is expected to reach about 7.5 percent for the whole year. In the year 2002, the following issues concerning economic operation should receive special attention if the sustained and steady economic growth is to be maintained.

I. The Impact of the Sluggish World Economy on China's Economic Development Should Not Be Underestimated.

In 2001, the world economic growth has visibly slowed down due to the recession in the United States and the prolonged downturn in Japan. The September 11 Event aggravated the situation, making the economic prospect of the United States and the world in general even gloomier. Morgan Stanley believes that the September 11 Event delayed the U.S. economic recovery and the global economy may have to face the biggest recession since World War II. The International Monetary Fund also warns of a longer and more severe global economic recession. In light of the conditions in major countries and regions, the world economy can hardly expect a visible recovery in 2002. Therefore, the impact of clearly increased uncertainties on China's economic development should not be underestimated.

The U.S. economic downturn appeared after a 10-year prosperity and the burst of the new economy bubble, and an adjustment and recovery will take a fairly long period of time. The September 11 Event has severely weakened the confidence of both consumers and investors and boosted the risk-averting consciousness of the people, which will have a profound indirect impact on the U.S. economy. As the consequences of the event are still unfolding, it is still difficult to determine their impact on the United States and the world political and economic order. The recovery of the U.S. economy is expected to delay for at least one year. Whether a recovery can appear at the end of next year still depends heavily on how the U.S. war against terrorism will develop and how the domestic consumers and investors will regain their confidence.

The European economy is still at a low ebb. Germany reported a zero economic growth in the second quarter, and Italy reported a 0.1 percent negative growth. In France, investment began to decline and the government expects the growth to be around 2.1 percent. Although the European Union countries have set the goal for a mid-term growth recovery, their economies can hardly expect a visible recovery due to the bleak U.S. economic prospect. The IMF forecasts that the GDP growth of the Eurozone countries would be about 2 percent in 2001 and 2002.

Japan's economic recession will deepen further. Its economic growth in the second quarter was negative 0.8 percent and its unemployment rate in July reached 5 percent, the highest level since World War II. As large numbers of enterprises went bankrupt and corporate debts rose, the bad assets of financial institutions remained high and investment confidence was extremely weak. In addition, consumption shrank and deflation sped up. The IMF forecasts that Japan's economic growth this year will be negative 0.5 percent.

Because of their close links with the U.S. economy, the economies in Southeast Asia were adversely affected. As these economies have lots of inherent structural and systematic problems and their foundation for recovery was not solid, their future development trend allows no optimism. The Asian Development Bank believes that the economies in East Asia have no hope of recovering this year and its growth is expected to be around 5.7 percent. Compared with this region's 7.5 percent actual growth in 2000, the trend of an economic downturn is quite obvious.

In general, the world economy will continue to be sluggish and uncertainties will increase. This will have a considerable negative impact on the development of the Chinese economy. First, export environment will deteriorate further. In the first three quarters of this year, export grew only by 7 percent over the same period a year ago, the increase was 26.1 percentage points lower. A continuing fall in export growth is inevitable next year, with its pulling effect on economic growth weakening further. Next, the problem of global overproduction, price fall and excessive competition will become even more conspicuous. All these will spread to China more visibly through price changes on the international market, import and other channels after China's WTO accession. This will increase the pressure of domestic deflation. Third, the sagging world economy, the sluggish stock markets and the increased financial risks will adversely affect the overseas fund raised by the Chinese government and enterprises. Fourth, the war against terrorism could aggravate regional conflicts, increase the uncertainties in the world political and economic order, and impair China's import of oil and other essential materials and its economic security.

On the other hand, we should also see that the changes in the international economic environment have created favorable opportunities for China to attract technologies and equipment and promote industrial restructuring and upgrading. Worldwide deflation, overproduction and fiercer competition have reduced the cost of China's imports. The Chinese currency RMB is in a state of relative appreciation against other foreign currencies except the U.S. dollar. The continuous increase in foreign exchange reserves has offered a favorable condition for China to import major technologies and equipment. China's excellent momentum of economic development and its enormous market potential have further increased its appeal to foreign capital and technologies. In the meantime, China is at a critical juncture in industrial restructuring and upgrading. Strengthening economic and technological cooperation and exchanges with energetic foreign enterprises and importing technologies and equipment for key areas and links will be of vital importance to enhancing the international competitiveness of the Chinese industries, narrowing their technological gap with foreign counterparts, meeting the challenges arising from WTO accession and easing bilateral trade frictions. At this moment, therefore, China should work out strategic plans for the import, the digestion of major technologies and equipment, the establishment of joint ventures and the cooperation by taking full advantage of the favorable opportunities arising from the changes in the international economic environment. China should not confine itself to realizing annual trade surplus and import-export balance. Instead, it should expand imports to promote the adjustment and upgrading of the industrial structure.

II. The Foundation for Sustained Expansion of Domestic Demand Is Still Not Solid.

Since the beginning of this year, while the contribution to economic growth by foreign demand has visibly weakened, the expansion of domestic demand has become the main driving force for economic growth. In the first three quarters, the total amount of fixed asset investment and the total amount of retailing consumer goods increased respectively by 15.8 percent and 10.1 percent, or 2.9 and 0.2 percentage points, over the previous corresponding period. Under the circumstance of continued sluggish world economic growth, China’s economic development next year will continue to rely on the expansion of domestic demand. In view of the present conditions, there are both factors promoting and restraining the growth of investment and consumer demand. As a result, the foundation is still not solid for a continued expansion of domestic demand.

Among the factors promoting the growth of investment demand, the growth of investment in real estate development continued to accelerate (the growth rate in the first three quarters was 31.4 percent higher than that of the previous corresponding period, or 3.2 percentage points higher than that of the first half of the year) and the growth of foreign direct investment picked up visibly (the growth rate in the first three quarters was 38.2 percent higher over the same period of last year). While the reform of the housing system further demonstrates its effects and the Chinese economy continues to grow steadily, real estate development investment and foreign direct investment will continue to maintain a rapid growth. With the progress in structural adjustment and the reform of economic system and with the continuous widening of investment venues for non-state-owned enterprises, the investment desire of micro subjects and the ability of spontaneous investment growth will rise further. At the same time, we should also see that expanding the scale of government bonds and discount loans can also play an important role in promoting investment growth. In addition, world economic downturn could trigger an all-round price decline in the international market, which will, through imports, increase the pressure of domestic deflation, affect expected returns of investment, increase investment risks and restrain spontaneous investment expansion. The growth rate of investment in upgrading and transforming traditional industries in the first three quarters was 2.8 percentage points lower than that in the first half of the year, and the growth of collective and private investment (9.1 percent higher over the same period of last year) was also lower than the level of last year. This indicates that the momentum of spontaneous investment growth was not steady. In addition, system and mechanism constraints also exist in the supply of investment funds. As a result, the posture of this year’s rapid investment growth will be difficult to be maintained in 2002.

Since the beginning of this year, the income of urban residents has risen steadily (the per capita disposable income in the first three quarters rose by 7.4 percent over the same period of last year), and the income growth of rural residents has been sharper (the per capita cash income rose by 5.2 percent). They were the main reasons for the slightly higher growth rate of consumer demand and will promote a further expansion of the urban and rural markets. However, conditions do not exist for a rapid and sustained income growth of farmers, and the widening of income gap, the decline in the purchasing power of urban low-income groups, the slow income growth of the residents in economically backward regions and other factors that constrain the expansion of consumer demand will be difficult to change in a short period of time. Because of the role of base, the effect of the extension of holidays, the collection of interest tax and other policies designed to support the growth of consumption is weakening. The steady slowdown of economic growth also has a delayed effect on the income growth of urban and rural residents. Therefore, the growth rate of consumer demand in 2002 could be slightly lower.

It is worth noting that since the beginning of the year, economic growth has been slowing down steadily on a quarterly basis. The growth rate was 8.1 percent in the first quarter, 7.9 percent in the first half of the year, and 7.6 percent in the first three quarters. The continued downturn of the world economy could further aggravate this trend. Therefore, the task to promote a sustained expansion of domestic demand and a steady growth of the economy will be very arduous in 2002. On the one hand, it is necessary to further emphasize the role of domestic demand expansion in promoting economic growth. On the other hand, deepening the reform is needed to eliminate the system and mechanism obstacles to economic growth.

III. Further Emphasize the Role of Domestic Demand Expansion in Promoting Economic Development

In recent years, the effective application of macroeconomic policies has played an important role in reducing the impact of the changes in the external environment on China's economic development, promoting a sustained economic growth and ensuring social stability. At present, we should be fully aware of the uncertainties associated with the changes in the external economic environment and we still have to see to what extent the Chinese economy can bear the external impact. In making fiscal and monetary policies, emphasis should be placed on the role of domestic demand expansion policy in promoting economic development, certain room should be left for maneuvering, and evolving conditions should be taken into account.

While proactive financial policies should continue to be implemented and due expansion intensity should be maintained, adjusting expenditure structure and using tax leverage should be the main tools to improve the efficiency of financial policies. First is to optimize the structure of fiscal expenditure. In addition to supporting the ongoing construction projects, the funds of government bonds should be used to intensify the support for the establishment of the social security system, for the payment of the expenses arising from developing rural public undertakings, and for the import, digestion and development of major technologies and equipment. Right now, the state can lend some funds from the government bonds to the local governments where economic foundation is relatively sound to support the infrastructure construction in their large and medium-sized cities. Second is to take full advantage of the favorable opportunities arising from fast revenue growth and integration with WTO rules, and to deepen the reform of tax system in an active and steady way so as to create conditions for the transition of value-added tax. The rule that the tax for the purchasing of fixed assets cannot be deducted from the productive value-added tax has increased the tax burden of the enterprises whose organic capital composition is high and investment scale is large. This problem should be paid more attention. Third is that while strict tax collection and management in recent years has resulted in a sustained rapid growth of fiscal revenue and played an important role in improving the "two low proportions" and increasing financial capacity, the rise in the actual tax payment of micro subjects has to a certain extent affected their desire and ability to expand production and increase investment. In view of the current fiscal conditions and the urgency of increasing the vitality of micro subjects, the growth rate of fiscal revenue for next year should be properly adjusted so that it will largely tally with the nominal GDP growth rate. Specifically, under the precondition of strict tax collection and administration, measures can be taken to reduce the tax burden of micro subjects and encourage investment and consumption. Such measures include balancing the income taxes between Chinese and foreign-invested enterprises, offering more tax incentives to small and medium-sized enterprises, reducing or exempting agricultural tax and the special tax on agricultural products, and raising the threshold for personal income tax collection. Fourth is to intensify payment transfers to the central and western regions. On the basis of strengthening infrastructure construction and protecting the ecological environment, support should be given to the key regions, industries and enterprises so as to increase the staying power of the economic development in these regions.

In implementing a sound monetary policy, the main task is to further allow monetary policy to promote economic development by maintaining a steady growth of currency supply, taking advantage of the leverage role of interest rates and easing the structural contradictions in fund supply. First is to increase support to the rural economy. Credits for production activities in rural areas are usually small in amount, scattered, and difficult to assess, and the current banking system is unable to meet the need of rural credit. This is also the main reason why usury is rampant in the rural areas. As a result, it is imperative to accelerate the construction of rural financial institutions, properly raise the floating margin of credit interest rates and improve fanatical service in the rural areas. Second is to increase support for small and medium-sized enterprises. While the state-owned commercial banks should continue to intensify their support for the small and medium-sized enterprises, it is necessary to establish a credit rating and guarantee system for these enterprises, regulate the development of small and medium-sized regional banking institutions, encourage the development of private banks, increase the rediscount scale for the small and medium-sized financial institutions and reduce the discount rates so as to smooth the fund-raising channels for these enterprises. Third is to accelerate the establishment of the funds for venture capital and initial investment, expand the interest rate floating margin of bank loans, and intensify financial support to high- and new-tech enterprises.

IV. Deepening the Reforms as A Fundamental Measure to Promote Economic Development and Meet the Challenges Arising from WTO Accession

The reform measures introduced in recent years have injected new vitality into economic development. They included the strategic adjustment of the distribution of the state-owned economy, the breakup of monopoly, the introduction of competitive mechanisms, the promotion of the development of private industries and the easing of the administrative control over the enterprises’ microeconomic activities. Right now, as there are more uncertainties in the external environment and China will soon join the WTO, deepening the reform and improving the socialist market economic system remain the fundamental measures for China to promote the development of its economy, increase the competitiveness of its industries and meet the challenges arising from WTO accession.

First, it is imperative to continue the reform of the state-owned enterprises and the development of private enterprises so as to increase the vitality of micro subjects. The strategic adjustment of the state-owed economy should be accelerated to further shrink its layout. The corporate governance structure of the state-owned enterprises should be improved, the management of the state-owned assets be standardized, the internal management be strengthened, and the modern corporate systems be established in the state-owned enterprises. The restrictions on the entry threshold for private enterprises should be eased and the investment channels be broadened for these enterprises.

Second, it is imperative to speed up the reform of financial, investment and fund-raising systems. In order to meet the need of opening the financial sector after WTO accession, it is necessary to gradually reform the state-owned banks, adjust the regulatory methods over their business activities and increase their self-development and risk-bearing abilities. It is also necessary to actively nurture and develop new investment and fund-raising institutions, introduce the ownership relationship of the residents' financial assets into the social investment and financing activities and establish system and mechanism for the development of venture and initial investment.

Third, in light of the new situation arising from WTO accession and in keeping with the requirements for integrating with the world economy, China should continue to streamline, revise or abolish the laws, regulations and policies that do not conform to WTO rules and increase their uniformity and transparency. In the meantime, the state should break up regional blockade and industrial isolation, and promote the development of a great nationwide unified market. It should also standardize the behaviors of market subjects, improve the credit system, and safeguard the rights and interests of market participants. In addition, market entry restrictions should be eased or abolished and the super-national treatment enjoyed by foreign-invested enterprises should be abolished so as to create an environment for fair competition among all legitimate economic subjects.

Fourth, China should accelerate the transformation of government functions and standardize government behaviors. In keeping with the commitments made for WTO accession, China should streamline and drastically reduce the government's administrative examination and approval procedures, and carry out reform, reorganization and regulation of the industries that enjoy natural monopoly and are of the nature of public undertakings. In addition, it should accelerate administrative and procedural legislation, standardize administrative powers and exercise administration according to law. The reform of the judicial system should be accelerated and judicial independence be strengthened so as to offer timely and impartial judicial services for the effective operation of the market economy. At the same time, administrative efficiency and personnel quality should be improved in accordance with the principles of competence, integrity and efficiency.

Fifth, China should speed up the establishment of social security system and increase the society's risk-bearing ability. A social security system which covers pention insurance, unemployment insurance and medical insurance for the entire society should be established and improved to offer a social safety net for the smooth development of the socialist market economy. At present, it is imperative to actively implement all the social security reform measures within the framework of integrating overall social pooling with personal accounts. It is particularly important to expand the coverage of pension insurance and unemployment insurance and increase the rate of collection so that all categories of enterprises in China will fulfill their social security obligations. It is necessary to ensure that pension funds and the basic living expenses for laid-off workers should be paid in full and in time and the system of ensuring minimum living requirements for urban residents be improved. The re-employment service centers established by the state-owned enterprises should be abolished as soon as possible in order to transit to socialized unemployment insurance. Finally, efforts should be continued to explore suitable systems of pension and public medical service in conformity with the unique features of the rural areas.


Project group on the Analysis of Macro Economic Situation

October 2001