Macroeconomic Trends and Policies

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Macroeconomic Trends and Policies

• Lecturer Zhigang Li

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Outline

• Trends
• Macroeconomic policies
• Stability
• Fiscal policy
• Monetary policy

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Household Saving Rates
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Saving (percent of GDP)
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Stability

• Unlike many other transitional economies (East
  Europe), Chinas transition has been generally
  stable.
• GDP
• Savings rate
• Some fluctuations
• Some hyperinflationary episodes but were well
  controlled

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How was stability achieved?

• Gradual transition
• Less uncertainty so that decision-makers in the
  household, business, and government sectors were
  able to adjust their saving and investment
  decisions gradually.
• Endogenous macroeconomic policies
• Policy that kept the real value of deposit
• Decentralization and recentralization

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National Saving

• Before the reform
• The state-owned sector was the main source of
  saving
• After the reform
• Household saving rates increased rapidly, making
  up for the loss of saving from state-owned sector
• As of 1995 households were generating 70 of
  domestic saving

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Why household saving increased dramatically after
1978?

• Income growth
• Reduced expected security in old age (e.g. due to
  the decline in the number of children)
• Household investment opportunities exploded
• Stable expectation of the future

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Banking and Macroeconomic Stability

• Bank as intermediate between saving and
  investment
• Household saving mainly rely on banks to convert
  them into investment. Efficiency of the
  conversion determines the impact of transition on
  national investment rate
• Banks as governments instrument to stabilize
  economy
• Strengthening government financing ability
• Continuing support for the state-owned sector
• Buffer negative shocks In 1995 banks pay 24 for
  long-term deposits but charge 14 for long-term
  loans.

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The Banking Sector

• Until very recently Chinas financial system
  lagged behind the rest of the economy in the
  transition process.
• The banking sector has been one of Chinas most
  protected industries.

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Assets of banking institutions

• 2003 2005
• Big Four 55 52.5
• Joint-stock banks 13.8 15.5
• City banks 5.3 5.4
• Others 25.9 26.6
• Policy banks 7.7
• Rural credit 9.6 9.9

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Features

• A large retail banking network, including rural
  credit cooperatives in nearly all townships.
• Financing for SOEs shifted strongly toward
  reliance on bank financing during the mid-1980s.
• The investments were highly inefficient an
  enormous stock of nonperforming loans built up in
  the banking system.

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Non-Performing Loans (NPL)

• By late 1990s NPLs were around 40 of total
  lending (usually it should be less than 5).
• Since 1998, the highest priority of policy makers
  has been to strengthen the financial system.
• Reduce the stock of NPL
• Control the flow of NPL

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Fiscal Policy

• Fiscal system
• Decentralization
• Fiscal reform 1994
• Expenditure and dificit

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Fiscal Decentralization (Tsui and Wang, 2004)

• Fiscal decentralization (starting in 1980s) was
  an attempt to give local governments more stable
  fiscal revenue and more flexibility in making
  local fiscal decision.

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Main Features of Fiscal Decentralization in China

• Intergovernmental Fiscal contracts
• Fiscal contracts between successive levels of
  governments define rules not to trespass on the
  tax rights of local governments.
• Local governments have ownership rights over
  their off-budget resources.
• Extra-budgetary revenue (charges levied by
  administrative and institutional units) grew at
  27 per year during 1982-95, reaching similar
  amount as the budgetary revenue.
• Extra-system revenue (e.g. profits from TVEs) is
  also significant.

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Trade-off of decentralization

• Positive
• Align the interest of local government with local
  economy, thus enhancing local growth
• Motivate local officials to collect taxes
• Negative
• Weakened ability for the central government to
  redistribute income, raising inequality
• Reduced power for the central government to
  control the macroeconomic economy, raising
  instability

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Trend of budget

• From 1978 to 1994 the budgetary share of GDP has
  declined steadily from about 34 to 10.8 percent.
• In other developing countries, the budgetary
  share was over 30 percent on average.
• Since 1994 the budgetary share steadily
  increased, reaching around 20 percent by now.

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Why budgetary share has declined since 1978?

• Small and shrinking tax base State-owned firms
  were the main contributor of fiscal revenue by
  remitting profits.
• In early 1990s the state sector produced 40 of
  GNP but contribute 80 of fiscal revenues.
• Incentive issue No uniform or stable agreement
  on tax sharing between local and central
  governments (case-by-case bargaining).

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The 1994 Fiscal Reform

• Replacing the revenue remittance system with a
  tax system state and non-state sector pay
  uniform tax rates
• VAT 17 percent for most firms (small firms pay
  6 of sales tax)
• Sharing of tax revenues between local and central
  governments is fixed.

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Central government share of budgetary revenue and
expenditure
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Intergovernmental Fiscal Transfers

• Rebate of taxes
• Accounting for 47 of central-local transfers in
  2000
• Increasing inter-regional fiscal inequality
• Discretionary transfers
• Account for 48.7 of total transfers
• For good purposes e.g. western development,
  education, social security
• No formal distribution rules, making it hard for
  the transfers to reach the bottom
• Provide incentive for poor regions to stay poor.

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Fiscal deficit policy

• Fiscal policy may shape macroeconomic conditions
  through running deficits (stimulating demand and
  the overall economy) or surpluses (restricting
  demand).
• Chinas fiscal policy has been passive and
  modest.
• Chinas fiscal deficits were kept within 1 of
  GDP in most years of 1980s and early 1990s.
• After 1998, China faced increasing pressure of
  unemployment (SOE layoff and East Asian Financial
  Crisis). China increased deficit well over 2 of
  GDP. As the economy went well, the deficit was
  reduced to 1.1 of GDP in 2005.

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Why the deficit policy of China has been modest?

• Possible reasons
• The stock of debt may actually be big. Although
  official debt was reported to be 18 of GDP,
  adjusted figure (including all types of
  government obligation) suggests that Chinas debt
  is 55 of GDP.
• Future spending demand (thus the demand for debt)
  may be very high. This is due to the possible
  need to finance the debt-ridden state banks and
  social security systems.

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Chinese Monetary Policy

• Two characteristics of monetary policy in China
• Passive and not independent
• Expansionary cycles have been accompanied by
  acceleration in credit provision. In contrast,
  during austerity phases credit supply was
  reduced.
• Interest rates have never been deregulated.
  Adjustments of interest rates have never been
  quick enough to fully reflect the range of
  cyclical effects. Real interest rates have been
  significantly negative during high inflation and
  significantly positive during low inflation.