Deflation in China

1
Deflation in China
2
Employment in China's Industries
3
Understanding Deflation in China

• External shocks
• Asian financial crisis, 1997-1999
• World economic slowdown, 2001 onward
• Accelerated restructuring of state enterprise
  sector, 1997 onward
• Keynesian maladies
• Paradox of thrift
• Liquidity trap
• Expansionary fiscal policy has helped keep growth
  above 7 percent, fiscal deficit is 3 percent in
  2002

4
Growing fragility of the bank system
5
Issues raised by NPL

• threat of bank runs (reduces financial
  intermediation)
• higher interest rate reduces capital formation
  (e.g. with one-third NPL, ignoring operational
  costs, cash-flow budget requires lending rate to
  50 percent higher than deposit rate)
• fiscal sustainability of state

6
International Perspective on Public Debt and
Public Revenue (percent of GDP)
7
Consequences of another bank recapitalisation

• Debt service to increase by 1.5 to 2.0 percent of
  GDP
• Spending on state capital construction in 2001 is
  2.6 percent of GDP
• Reduction in state capital spending or increase
  in taxes?

8
Some macroeconomic challenges

• financial sector overhaul to eliminate the two
  Keynesian maladies
• fiscal sustainability as prerequisite to prevent
  bank runs, and to maintain fiscal stimulus
• threats to fiscal sustainability recurring
  rounds of bank recapitalisation, public health
  needs