China has received much attention in recent years as its economy has performed exceptionally well by most standards: after a soft landing from an episode of overheating in the mid-1990s, the Chinese economy managed to weather the Asian crisis of the late 1990s largely unscathed and has been able to sustain rapid growth in the face of the recent global downturn.1 At the same time, however, analysts point to serious structural weaknesses in China’s economy, such as problems in the state-owned enterprises (SOEs) and banks, growing unemployment and income disparities, weak governance and corruption, medium-term fiscal pressures, and environmental degradation. There is concern that these challenges, if unmet, could undermine sustained rapid growth and stability. The key task facing policymakers in China today is how to sustain the economy’s growth and development while spreading the benefits more widely across society. This book looks at those challenges and China’s efforts to meet them—issues that have been at the center of policy analysis and discussion by IMF staff working on China in recent years.
1. International financial crises in the late 1990s underscored the importance of disseminating comprehensive information on countries’ international reserves and foreign currency liquidity1 on a timely basis. Deficiencies in such information have made it difficult to anticipate and respond to crises by obscuring financial weaknesses and imbalances. (See Box 1.1) Moreover, both the complexity and the importance of such information have increased as a result of the ongoing globalization of financial markets and financial innovations. The international financial activities2 that countries’ central banks and government entities undertake now occur in myriad forms, involve multiple domestic and foreign entities, and span locations around the globe. To assess countries’ foreign currency liquidity requires supplementing traditional data on international reserves that cover largely cross-border and balance-sheet activities with those on foreign currency positions and off-balance-sheet activities.
The past two decades have witnessed great strides in China’s financial system transformation. The authorities replaced the monobank system—typical of centrally planned economies—with a multilayered system and placed a central bank at the helm.1 In 1994, they created policy banks to take over policy lending duties from the state banks. A commercial bank law, enacted in 1995, laid the foundation for commercially oriented banking. The authorities intensified reform efforts in the wake of the Asian financial crisis and established asset management companies (AMCs), recapitalized banks, and restructured trust and investment corporations and small and medium-sized financial institutions. They strengthened prudential regulations through the introduction of a new loan classification and provisioning standards that approach international best practices. State-owned banks have taken steps to strengthen corporate governance, increase transparency, consolidate branch networks, and downsize staff. Also, stock, bond, and money markets are being developed. Finally, with its entry into the World Trade Organization (WTO), China has committed itself to allowing full market access to foreign banks by 2006.
Solving the closely related problems of the state enterprise and financial sectors and of China’s medium-term fiscal sustainability represents the central economic challenge facing China. The weak performance of the state-owned enterprises (SOEs) has burdened the state commercial banks (SCBs) with a large amount of nonperforming loans, creating contingent liabilities that could threaten medium-term fiscal sustainability. Although the authorities have made progress in improving the governance and performance of the SOEs and the SCBs, the remaining agenda is formidable, and the financial costs of reforms are high but difficult to quantify. The difficulty of quantifying the costs of reform is exemplified by the substantial and still-continuing revisions made to measures of asset quality in the financial system.1
After 14 years of negotiations, China acceded to the World Trade Organization (WTO) on December 11, 2001. A key step in negotiation of the final agreement, the U.S.-China bilateral agreement, was reached on November 15, 1999, and is generally regarded as the core of the final agreement. Because this document was made public at the time the agreement was reached, whereas other bilateral agreements have not been, there has been greater opportunity to assess its impact, and some of the material referenced below is based on this bilateral agreement. More recently, an official summary by the WTO of the entire agreement has been released, and the first outside assessments of the entire agreement are now becoming available (WTO, 2001). Some additional information is available on the bilateral agreements with the European Union and with other countries, even though the texts of these agreements have not been made public. The summary of the key features of the agreement below is based on the WTO summary and, to a lesser extent, the U.S.-China bilateral agreement (Boxes 12.1 and 12.2 provide additional detail):
Although China’s exchange rate regime is officially described as a managed float, the renminbi has in practice been tightly linked to the U.S. dollar, especially since the Asian financial crisis.1 This policy was credited with serving as an important anchor of stability, both for China and the region, during this period. However, as the region has stabilized, the question has arisen whether China should allow greater flexibility of the renminbi, particularly in light of continued rapid structural change in the economy, including as a result of World Trade Organization (WTO) accession.
Over the past two decades, China has been one of the fastest-growing countries in the world.1 Growth in real GDP per capita has exceeded 8 percent a year on average, an impressive achievement even by East Asian standards. China’s exceptional growth performance has been spurred by market-oriented structural reforms introduced since the late 1970s, which have also resulted in sizable productivity gains. However, annual GDP growth has declined since 1993, to 7–8 percent in 1999–2001, raising questions about to what extent China’s impressive track record can be sustained in the future. Although most analysts believe some slowdown is inevitable, it is difficult to assess China’s future growth potential given the deep structural reforms under way, the vast scale of the Chinese economy, and the complexities of its growth dynamics.