Recent Economic Developments

This paper reviews macroeconomic developments in China in 1994 and 1995, in particular the progress achieved during these years in “cooling” the economy following the intense overheating that originated in an investment boom in 1992. During 1994, efforts were intensified to achieve macroeconomic stability, with some initial headway being made in slowing the pace of economic activity. In 1995, demand and output further moderated toward more sustainable rates, with inflation declining steadily from the record high levels of 1994 to single-digit levels by end-1995.


This paper reviews macroeconomic developments in China in 1994 and 1995, in particular the progress achieved during these years in “cooling” the economy following the intense overheating that originated in an investment boom in 1992. During 1994, efforts were intensified to achieve macroeconomic stability, with some initial headway being made in slowing the pace of economic activity. In 1995, demand and output further moderated toward more sustainable rates, with inflation declining steadily from the record high levels of 1994 to single-digit levels by end-1995.

Introduction 1/

This report reviews macroeconomic developments in China in 1994 and 1995, in particular the progress achieved during these years in “cooling” the economy following the intense overheating that originated in an investment boom in 1992. The boom was fueled by expansionary financial policies, contributing to an inflationary surge and disorderly conditions in financial exchange markets. Stabilization efforts initiated in mid-1993 met with some initial success but a premature relaxation of policies in late 1993 contributed to a resurgence in inflation. Although administered price increases and supply problems were also significant contributory factors, rapid monetary expansion further fueled by a growing external surplus accommodated much of the increase in inflation. During 1994, efforts were intensified to achieve macroeconomic stability, with some initial headway being made in slowing the pace of economic activity. In 1995, demand and output further moderated toward more sustainable rates, with inflation declining steadily from the record high levels of 1994 to single-digit levels by end-1995. The external position remained strong in 1995, owing to robust albeit moderating export growth and continued sizable inflows of foreign direct investment. These developments took place against the background of some further tightening of financial policies and intensified controls of investment spending; improved food supplies; and stepped-up administrative measures to dampen inflation; as well as an acceleration of the structural reform process.

I. Real Sector and Price Developments

1. Overview

During the last two and a half years China made significant progress cooling the severely overheated economy (Table 1 and Appendix Table 18). 2/ In the process of stabilization, the authorities set out to gradually slow demand, redirect investment to relieve capacity constraints, and accelerate structural reforms. Cutting back on the excessive investment in fixed assets was the top priority, but success only came slowly because of momentum built up by the large number of newly started projects in 1992-93. 3/ Further, in 1994 the modest slowing of domestic demand was offset by a marked improvement in net exports (of 4 percent of GDP).

Table 1.

China: Grots Domestic Product end Expenditure, 1990–95 1/

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Sources: State Statistical Bureau; and staff estimates.

Data based on information available in January 1996. Although an estimate of Y 5,770 billion for total GDP for 1995 was announced, this total was not used because details of components and related revisions to earlier data were not available.

Also, data for 1994 differ from the 1995 Statistical Yearbook, in that consumption in this table was estimated as a residual to keep the statistical discrepancy at about the same level as in 1993. In the 1995 Yearbook, the discrepancy was Y 147.5 billion or 3.3 percent of GDP.

Although accelerating sharply in 1994, inflation declined steadily in 1995. 1/ Inflation fell to 8.3 percent in December 1995 (12-month basis) and 14.8 percent (annual average) for the year, consistent with the Government’s (annual average) inflation target of 15 percent.

2. Demand developments

The policies to control the overheating in 1993 focused on restraining the rapid growth of demand, which was driven mainly by fixed asset investment. In 1991–93, the ratio of fixed investment to GDP (in nominal terms) increased by at least 10 percentage points (Charts 1 and 2) offset partly by subdued consumption and less stock accumulation, as well as by a reduction in net exports. In contrast, in the last two years, net exports improved by about 4 percentage points; the slowing in demand came from a reduction in fixed investment in relation to GDP as well as from further declines in the growth of consumption and some reductions in stock accumulation. 2/



Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: China Statistical Yearbooks; and staff estimates1/Calculated as the change in these aggregates as a percent of GDP in 1991–1993, and 1993–1995.

china SOURCES OF GROWTH, 1989–95

(In percentage points)

Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.1/ Staff estimates, as official statistics do not provide a breakdown of demand components of GDP.

a. Invesment

The policies to restrain investment included limits on investment approvals and bank credit. Although fixed asset investment slowed substantially in nominal terms, several factors contributed to the still relatively high (31 percent) nominal growth in 1994 (Appendix Table 19). 3/ First, a large number of projects had already been started in 1993 and many took more than a year to complete. Second, the impact of credit restraint on enterprises was initially felt more on wage payments than on investment projects. Third, the slower growth of financing of state-owned units by banks and the budget was offset by increased foreign financing (which nearly doubled) and increased use of internal financing by enterprises (Appendix Table 20). 4/ However, the policies to slow investment continued in 1995 and investment growth slowed to about 20 percent (national accounts basis), reducing the fixed investment to GDP ratio slightly to about 37 percent.

The policies to slow investment also focussed on improving its composition. In 1993 the increase in fixed investment was largely in commercial projects, but especially luxury housing and offices in coastal cities. Real estate development increased by 150 percent, while investment in agriculture stagnated (Table 2). The investment control measures in 1994 and 1995 aimed at redirecting investment away from real estate to address supply bottlenecks in the economy, mainly by giving priority to infrastructure and agriculture. Therefore, real estate development projects were scaled back and many projects in less prime locations were idled, although investment in housing for urban residents increased. Investment in transport and communications, though also scaled back, remained relatively strong in 1994–95, marked by heavy investment in roads and railways. Investment in agriculture was stepped up and grew by 40 percent in 1995, albeit from a low base. From a regional perspective, investment growth slowed to close to zero in the southern coastal provinces where it had been the strongest in 1993 (Table 3).

Table 2.

China: Capital Construction of State-Owned Units, 1993–95

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Sources: China Statistical Yearbook; China Monthly Statistics; and China Economic Developments.

Data for 1995 estimated from data through November 1995 on capital construction and total investment of state-owned units.

Table 3.

China: Investment by State-Owned Units, by Region, 1993–95

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Source: Data provided by the State Statistics Bureau.

Data for 1995 estimated from total fixed investment, investment by state-owned units increased by 17.5 percent in 1995.

The rate of stock accumulation appears to have slowed in the last two years. In 1993 the increase in inventories had accounted for almost 6 percent of GDP, up from 5 percent in 1992, owing partly to the buildup of unsold industrial products as the construction boom in 1992–93 started to slow.

b. Consumption

Consumption increased by about 25 percent in each of the past two years, a slightly slower rate than the growth in incomes. 1/ The saving rate rose by about 2 percent of GDP in 1994, leading to a large increase in time deposits at banks. In 1995, the saving rate fell slightly as consumption proxied by retail sales (Appendix Table 21) increased by 24 percent (7 percent in real terms), in part reflecting increased rural incomes from higher food prices in the previous year. 2/

Increases in real income have allowed significantly higher consumption standards in recent years. As the basic necessities (housing, medical treatment, and some food) continue to be provided to many urban residents at low cost, income gains were largely spent on discretionary items. In many of the large cities, spending increased substantially on recreational activities, consumer and entertainment appliances, and higher quality clothes and food.

3. Production developments

Industrial production growth slowed to 16 percent in 1995 from over 21 percent in 1993 and 1994, respectively (Appendix Table 22). 1/ The slowdown was concentrated in heavy industry, as the demand for construction materials weakened. The growth of light industry increased slightly in 1994 as capacity increased as a result of the completion of projects. In 1995 the growth of output of household electrical appliances, microcomputers, and agricultural inputs (pesticides, fertilizers, and small tractors) was robust. Total energy production grew by about 4 percent in 1995, partly reflecting lower production, especially by loss-making coal mines. (Appendix Table 23).

The share of the state sector, which had accounted for 43 percent of industrial output in 1993 (at current prices), declined to 34 percent in 1994, and fell further in 1995. In 1994 the value of the output of collectives exceeded that of state-owned enterprises for the first time. Output of state owned enterprises (at 1990 prices) grew by less than 10 percent while collectives and private enterprises grew by over 20 percent in 1994–95. Small state-owned enterprises were the most severely affected by tighter credit since they had inadequate working capital and relied excessively on bank credit.

Adverse supply conditions and competition with commercial developments for land and labor contributed to a slowing of the growth rate of agricultural output to 4 percent in 1994. Grain production, which had reached a record level of 457 million tons in 1993, fell to 445 million tons in 1994 (Appendix Table 24). Under a major program launched to revitalize agriculture in 1995, provincial governors were made responsible for grain output and promoting agricultural development. The production of fertilizer and other farm inputs was increased and subsidized fertilizer was sold to those farmers providing grain to the state at official procurement prices. In 1994 and 1995 the central government instructed local governments to pay farmers in cash for their grain, rather than the paper promises to pay, used in 1993. Local government levies on farmers, which had posed a heavy burden on farmers’ finances, were abolished in 1994. As a result of these actions and better weather, value added of agriculture grew by 5 percent in 1995 and grain production rebounded to 465 million tons. The production of high value farm products, such as meats, aquatic products, and vegetables, also increased sharply. However, cotton production continued to stagnate in 1995 and state control was re imposed over cotton procurement and distribution to avoid the excessive leakages to private distribution channels.

4. Prices and incomes

Inflation developments in 1994 and 1995 were dominated by a sharp rise and subsequent fall in food price inflation; the nonfood component was much more stable (Table 4 and Chart 3). After rising sharply in late 1993, the escalation in food prices continued in 1994, reaching over 40 percent towards year-end, before falling back to about 10 percent at end 1995. The growth of nonfood prices gradually slowed to about 10 percent in 1994, and fell further to 7 percent in 1995. For 1995 as a whole, the inflation rate declined by about 7 percentage points (on an annual average basis) to 15 percent (RPI) and 17 percent (CPI) (Appendix Table 25).

Table 4.

China: Selected Inflation Measures, 1992–95

(In percent)

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Sources: State Statistical Bureau; and staff estimates.


Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.

The sharp increase in food prices in 1994 was largely the result of a 40 percent adjustment in food grain procurement prices. 1/ The increase in food grain procurement prices of 40 percent in June 1994 was accompanied by an increase in many other food prices. Thus over the year to December 1994, grain and meat (where grain is an input) prices rose by about 50 percent. The policies undertaken in 1995 to improve food production and increase food imports contributed to a substantial slowing of food price rises, especially in the second half. Food prices slowed despite a sharp pickup in agricultural input prices that resulted initially from exchange rate unification (for imported inputs) and substantially due to demand pressures, especially for fertilizer. In 1995, prices of agricultural inputs rose by 27 percent.

To prevent the food price adjustments from becoming entrenched in inflation expectations, “enhanced price surveillance” was implemented from August 1994. This included much more widespread posting of prices, especially in small markets, and greater use of price inspectors. In addition, a larger proportion of prices were subject to fixing or guidance (Appendix Tables 2628). In terms of retail sales, the proportion of sales subject to price fixing or guidance, which had been reduced to 6 percent in 1993, was increased to 10 percent in 1994, with a similar pattern for agricultural output. 2/ To contain price rises, local governments are reported to have sharply increased price subsidies on basic necessities, mainly in the large cities for basic foods. 1/

There were marked differences in regional inflation. With the boom in fixed asset investment in 1993, prices in urban areas increased faster than in rural areas. In contrast, in the second half of 1994 prices in rural areas increased at a faster pace reflecting higher increases in food prices. Price rises in the large cities eased up from late 1994, as construction activity slowed and the associated demand pressures from migrant workers eased up, but stepped up price surveillance and subsidies may have also contributed.

During the past two years personal incomes rose rapidly. 2/ Urban incomes increased by 36 percent (about 9 percent in real terms) in 1994, due to the large salary adjustment at the start of 1994 in the state-owned sector (government and enterprises), and by 22 percent (5 percent in real terms) in 1995 (Appendix Table 29). Reflecting the large increase in procurement prices, rural incomes also increased significantly—by 32 percent (8 percent in real terms) in 1994 and 29 percent (5 percent in real terms) in 1995.

5. Employment trends

a. Urban employment and unemployment

According to official data, the growth of urban employment in 1994 and 1995 was relatively weak, with declines in employment in parts of the public sector, state-owned units, and collectives, offset by strong growth in the other sectors. Underlying employment growth in 1994 was about 2 percent, 3/ slightly below the average employment growth of 2 1/2 percent in the early 1990s (Table 5). Employment growth in 1995 was also subdued reflecting the further slowing of economic growth.

Table 5.

China: Labor Force and Employment, 1990–95

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Source: State Statistical Bureau, China Statistical Yearbook, issues for 1990–95.

Economically active population 16 years and older, excluding students and hose labor.

Foreign-funded enterprises.

Employment in the state-owned units (SOUs) has fallen since 1993, reflecting mainly slower employment in state-owned enterprises’ (SOEs) (which account for the bulk of the SOU sector) and has been attributable to both a decrease in recruitment and an increase in departures of existing workers. New recruitment by SOUs fell by about one half during 1990–94 while departures have been influenced by reform initiatives and a rapid aging of the SOE workforce. During the Eighth Five-Year Plan (1991–95) period, the share of employment of SOEs in total urban employment fell from about 49 percent in 1991 to 44 percent in 1995.

The two main factors behind the decline in employment in SOEs over the last two years appear to be the continuation of SOE reforms and restructuring, as well as the slowing of economic growth. 1/ Some SOEs have responded to increased market pressure by restraining recruitment and, in some instances, by shedding labor. The State Statistical Bureau (SSB) estimates that layoffs by SOEs reached 350,000–400,000 in 1993–94, double the rate in the preceding two years. Further, a growing number of workers were “separated from their jobs,” but not officially from their enterprises, and were paid only a portion of their wages. Although official estimates are not available for the size of this group, a recent report suggests that it may be sizable—equivalent to 2.0 percent of the urban labor force or 4.8 percent of workers employed in SOEs. 2/

The rest of the state sector, namely, government and quasi-government institutions, also appears to have reduced employment since 1993. The government civil service reform, which was launched in 1992, was intended to reduce overall staffing by 20–25 percent by the year 1997. In many cases, however, labor separated from government departments have joined quasi-government units whose budgets are in part supported by the Government.

Employment in urban collectives fell by 2 1/2 percent in 1995, continuing the trend of the last two years, with the decline reflecting the high sensitivity of this sector to cyclical pressures. Collectives have less stable access to credit from financial institutions than SOEs and thus have been under greater pressure to reduce costs as the economy has slowed.

Employment of foreign-funded enterprises (FFEs) continued to grow strongly (26 percent) in 1995 after a 40 percent increase in 1994, reflecting the sizable increase in foreign direct investment inflows since 1993. These high employment growth rates have substantially increased the relative importance of FFEs employment in total urban employment, from close to 2 percent in 1992 to about 6 percent in 1995.

The urban unemployment rate has been rising since 1992–93, reaching almost 3 percent by end-1995, but has varied widely across provinces. While it remains low by international standards, much of China’s unemployment may be “disguised” within the SOEs. While there are no firm data, the authorities estimate disguised unemployment to account for 15–30 percent of total employment of SOEs (between 11 million to 22 million in 1995). Taking into account this disguised unemployment, the underlying unemployment rate would be much higher than the official estimate.

b. Rural employment and unemployment

In the case of rural employment, township and village enterprises (TVEs) have been the major source of growth—which averaged about 5 percent per year during 1990–95. As a result, their share in the total labor force reached 19 1/2 percent by 1995, absorbing about one quarter of the rural labor force. Employment in TVEs, however, has been very susceptible to cyclical swings in demand with marked, but temporary increases during periods of strong economic activity.

A significant part of the rural labor force that is not employed by TVEs is not fully employed. Rural surplus labor has been the main source of the large migration to cities and townships that has taken place since the early 1990s; this so-called “floating population” is estimated to be around 70 million—one sixth of the rural labor force. This migration has been spurred by growing regional income disparities and the rising demand for unskilled workers in wealthier coastal provinces. Until relatively recently, administrative measures served to restrict the flow of large numbers of rural workers. The transfer of rural workers to the cities and townships is tightly controlled and thus these workers are not entitled to urban subsidies or entitlements accorded to formal urban residents. The gradual reduction of urban subsidies, however, and the increased provision of public services by private providers have reduced the barriers for rural migrant workers into the cities. As the large influx has put pressures on urban services, in 1995 local governments tightened the management of cross-province labor migration.

The emergence of the floating population has blurred the strict rural and urban divide and has influenced the Government’s approach to urban development. The Government’s small-town development strategy, which is an element of the Ninth Five-Year Plan (1996–2000), is a response to the many issues posed by the floating population, including the basic challenge of providing gainful employment to the large rural labor force.

6. Labor market reforms

The goal of labor market reform in China is to establish well-functioning markets as the principal means of labor allocation, while reforming the state labor policy of the economic planning era, particularly with regard to SOEs and governmental units.

In the case of SOEs, the Government promulgated the New Operation Mechanism in 1992, in which SOEs were given the autonomous right of hiring and firing, along with 13 other management rights. Even earlier, SOEs had started replacing life-time employment with labor contracts. The Ministry of Labor expects that before long most employment will be covered by labor contracts.

To support SOE reforms and restructuring, which inevitably entails labor reallocation and shedding, the Government has stepped up labor retraining programs, intensified efforts to put together a safety net for affected workers, and accelerated the development of the necessary institutions. The Government uses tax and credit incentives to encourage enterprises to employ unemployed workers—the so-called “employment service enterprises” now totaling near 20,000. 1/ A number of employment information and job placement offices are now operating in the country while trade union offices are playing an important role in assisting workers in financial distress. Although the coverage of unemployment insurance is still relatively narrow, at end 1994, the number of people receiving unemployment benefits reached 1.8 million.

The civil service reform was launched pari passu with the reorganization of the Government in 1992. The State Council has now completed job reclassification and reassignment established systems of nationwide civil service examination, personnel management, staff deployment (including staff layoffs), and conflict-of-interest management. The Government also implemented a wage reform in October 1993, with four categories of civil service wages and the ratio of the highest to lowest wage of civil servant being 6:1. 2/ The civil service reform is expected to be completed by the first half of 1997, by which time a total of 20–25 percent of government jobs, or 2 million, will have been eliminated.

II. Money and Credit Developments

During 1994–95, overall monetary and credit policies were relatively restrained, and important steps were taken toward strengthening the role of the central bank, further developing the indirect instruments of monetary control, and increasing the independence and market orientation of commercial banks.

1. Overall money and credit developments

Money and credit developments in 1994 and 1995 are to be viewed against the background of the authorities’ efforts to cool the economy from the intense overheating in 1993. An adjustment program was introduced in mid-1993, an important focus of which was to regain macroeconomic stability. The attendant credit tightening led, however, to liquidity problems among state-owned enterprises (SOEs) which, in turn, was followed by a relaxation of credit by banks in late-1993 which continued into 1994. After the third quarter of 1994, as a result of intensification of efforts to achieve macroeconomic stability, growth in monetary and credit aggregates slowed (Table 6 and Chart 4). The slowing was sharper for the narrower aggregates than for broad money as there was a reintermediation into the banking system, reflected in a strong increase in bank deposits of enterprises and households. The slowing in monetary aggregates in 1994–95 was achieved despite a large increase in net foreign assets (NFA) of the banking system that partially offset domestic credit restraint.

Table 6.

China: Monetary Survey, 1991–95 1/2/

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Source: People’s Bank of China.

Includes the operations of the People’s Bank of China, specialised and universal banks, rural and urban credit cooperatives, and the Agricultural Development Bank.

Level data from March 1993 have been revised on the basis of a new statistical methodology that includes an improved accounting system and expanded coverage. Growth rates from 1994 are based on these new statistics.



Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.

The narrow monetary aggregates started to slow after September 1994, and by end-1995 were broadly in line with the authorities’ objectives. Narrow money (Ml) growth, which was 33 percent in September 1994, declined to 17 percent by end-1995, while currency growth was reduced from 27 percent to 8 percent. 1/ Growth in reserve money, which peaked in June 1994, declined from 43 percent to 21 percent, compared with a target of 20–23 percent (Table 7).

Table 7.

China: Operations of the People’s Bank of China, 1991–95 1/

(In billions of yuan: end of period)

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Source: People’s Bank of China.

Data from March 1993 have been revised on the basis of a new statistical methodology that Includes an improved accounting system and expanded coverage.

Reserves converted at official rate prior to 1994.

Growth in broad money, while slowing after September 1994, was faster than targeted and also exceeded the growth rates of the narrower aggregates. At 30 percent by end-1995, it was lower than at end-1994 (35 percent) but above the 20–25 percent range that had been targeted. During the period after September 1994, it was faster than growth in the narrower aggregates, notably reserve money. This was a reversal of the pattern in 1993 when broad money growth was outpaced by reserve money following disintermediation from the banking system. 2/ During 1994–95, reintermediation was reflected in a surge in’ longer-term bank deposits of enterprises and households. The growth in deposits, evidenced by a near doubling of saving deposits in deposit-money banks (DMBs) between end-1993 and end-1995, led to a significant rise in the quasi-money component of broad money during 1994–95 compared with 1993 (Table 8). Broad money growth exceeded that in the narrower aggregates also in part due to financial innovations that helped agents to economize on narrow money holdings; the innovations included greater use of credit cards and automatic teller machines and the spread in the practice of enterprises directly depositing workers’ wages in banks.

Table 8.

China: Monetary Aggregates, 1991–95 1/

(Annual average, in percent of GDP)

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Source: Staff estimates, based on data provided by the Chinese authorities.

Official data on the levels of monetary aggregates during the period after 1993 are based on a new statistical methodology, and are thus not comparable to data relating to earlier years. The calculations reported in this table are based on an “adjusted” monetary series, constructed by extrapolation based on official growth rates, in which data are comparable across years.

The growth in bank deposits was attributable to several factors, including greater financial stability, higher household and enterprise saving, and increased competition to attract deposits. During 1994, the disorderly financial conditions that had prevailed during much of 1993, including for example the setting up of unauthorized deposit schemes by non-bank entities, continued to wane (e.g., with continued enforcement of regulations, initiated during the 1993 adjustment program, to restrict such schemes). Deposits were also boosted by the inflation subsidization begun in 1993 of interest rates on household deposits with maturity of three years and longer, which prevented the real rates on these deposits from turning negative, 1/ and by the uncertain performance of alternative vehicles of saving such as the stock market. In addition, the rise in household and enterprise savings, reflected in a rise in national saving from 40 percent of GDP in 1993 to over 43 percent of GDP in 1994–95, contributed to the rise in time deposits. At the same time, banks competed to attract deposits, including through work incentives based on deposit mobilization and provision of improved services.

The sources of reserve- and broad-money growth changed over the last two years. Credit by the PBC to financial institutions, historically the main component of reserve money growth, was relatively restrained; however, it was accompanied by large increases in net foreign assets (NFA) of the PBC. During 1994–95, roughly two thirds of reserve money growth was due to increases in UFA at the PBC (Table 9 and Chart 5). Budgetary borrowing, which had contributed roughly a third of reserve money growth in 1992, made only a small contribution in 1993 and negative contributions subsequently. The latter reflected a buildup in Government deposits associated with the large sales of Treasury bonds, and the termination, under the PBC Law (discussed below), of gross PBC lending to the Government in all but exceptional circumstances.

Table 9.

China: Contributions to Reserve Money Growth, 1992–95

(Percent of initial stock of reserve money)

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Source: Based on data provided by the Chinese authorities.


(Change over 12 months as percent of initial stock of reserve money)

Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.

With regard to the sources of broad money growth, while domestic credit continued to be the main contributor, there was a significant increase in the contribution of NFA in 1994 and of “other items, net” (OIN) of the banking system in 1995 (Table 10). In 1995, OIN accounted for as much as one fifth of the increase in broad money.

Table 10.

China: Contributions to Broad Money Growth, 1992–95

(Percent of initial stock of broad money)

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Source: Based on data provided by the Chinese authorities.

Domestic credit growth, like broad money growth, picked up during the first three quarters of 1994 but slowed thereafter. It declined steadily for the next twelve months before picking up somewhat in the final quarter of 1995. In 1994, while there was some periodic easing of credit in response to the needs of state—owned enterprises (SOEs), the increase of credit under the credit plan—which accounted for 70 percent of the credit extended by DMBs—was limited to 20 percent, consistent with the revised plan; the related credit ceilings were respected. 1/ In 1995, the increase of credit under the credit plan was 20 percent, compared with a target of 18 percent. 2/ There were some indications that credit began increasingly to be allocated according to market criteria, with creditworthy, efficient SOEs having proportionately greater access to loans than poorly-performing SOEs.

2. Operations of the People’ Bank of China

During the second half of 1994, the PBC took measures to curb reserve money growth. It substantially tightened its credit to banks, recalling credit to state banks (Y 34 billion) and increasing special deposits

(Y 10 billion) during the third quarter. 1/ The stock of PBC’s net claims on financial institutions fell by nearly one half during the last two quarters, despite a modest increase in gross credit to financial institutions. The effect on reserve money was, however, blunted by a sharp increase in net foreign assets (which, after nearly doubling between end-1993 and June 1994, to Y 308 billion, increased to Y 445 billion by year end). In 1995, a further strong increase in NFA (50 percent) was sterilized to some extent, including through some recalling of PBC lending. During the last quarter, the PBC issued Y 20 billion worth of central-bank financing bonds to financial institutions, an open-market-type operation to mop up liquidity. Claims on financial institutions were strictly limited, contracting through the first half of the year before rising in the second half mainly on account of lending for agricultural procurement.

The PBC’s operations during the period were marked by an increase in its operational autonomy and use of a range of intermediate monetary objectives and instruments in addition to credit expansion under the credit plan. 2/ Under the PBC Law, passed in March 1995, the PBC received a measure of operational independence from Government departments, and was explicitly required to report only to the State Council; became free of budgetary pressures, as gross lending to the budget was terminated in all but exceptional circumstances; received a clear mandate to maintain the value of the renminbi with a view to promoting growth; was vested with powers of banking supervision and prudential control; and was asked to form local branches based on economic, rather than administrative, regional divisions (in part as a further effort to limit the influence of local governments). Regarding the intermediate objectives of monetary policy, in 1995 the PBC monitored a range of monetary indicators—for currency, narrow money, reserve money, and broad money in addition to the credit plan, a practice which is to continue.

While direct credit controls remained the most important monetary policy instrument, other instruments, such as central bank lending, reserve requirements, and changes in administered interest rates continued to gain in importance, so that monetary policy was implemented through a blend of direct and indirect instruments. Direct controls were increasingly ineffective and difficult to apply, as they were in many cases inconsistent with reforms in the rest of the economy which emphasized decentralized economic decision making. The reduced effectiveness of the main direct instrument, the credit plan, was evidenced by the planned limits on credit expansion often being exceeded, some tines by substantial margins, and by widespread indications of leakages from the plan as credit was diverted to other uses. 1/

The PBC increased its reliance on other monetary policy instruments. The role of PBC lending to banks, which traditionally both filled the gap between banks’ deposits and their credit quotas and sought to manage overall bank liquidity through the granting of short-term credit, was strengthened. As the importance of the credit plan diminished, so did the importance of the “gap filling” role of PBC lending, which instead was increasingly used as an instrument for liquidity management. In addition, the 1993 decision to centralize the major part of PBC lending at headquarters led to banks improving internal liquidity management. Credit from the PBC to banks was more flexibly used during the period; as mentioned, when banks’ liquidity was considered high, PBC credit was recalled and special deposits raised. Open-market-type operations were introduced in 1993, in which the PBC used central bank bills to influence the level of liquidity in the financial system. 2/ Reserve requirements continued to play only a limited role in monetary policy, mainly because the relatively high level of excess reserves constrained the potential effect of changes in reserve requirements. 3/ The traditionally high excess reserves ratio in China has owed much to money markets being illiquid and not fully integrated, necessitating banks to keep a large cushion of reserves to meet operational needs. In addition, the underdeveloped payments and settlement systems contributed to the high excess reserves ratio. At the same time, until 1994, the reserve requirement and excess reserves guideline were imposed on a branch-by-branch, rather than a consolidated (bank-wide), basis so that shortfalls in one branch could not be offset by surplus reserves in other branches of the same bank. During 1995, the excess reserves guideline began to be applied on a bank-wide basis. The decision, by improving the ability of the PBC to assess liquidity developments, strengthened the link between reserve requirements and liquidity monitoring and management, and gave banks greater responsibility in managing their reserves. Together with preparatory moves for the January 1996 launch of the nationally-unified interbank market, 1/ and greater operational autonomy of the banks, it contributed to improved efficiency in reserve management. 2/ Interest rates on PBC credit to banks and on bank lending, which traditionally remained fixed for long periods of time, were adjusted more frequently and financial institutions had some flexibility in their use (discussed below, although absence of interest-rate liberalization continued to be a constraint on the effectiveness of indirect instruments).

A troubling recent development was the emergence of unidentified net domestic assets—“other items net” (OIN)—in the PBC’s balance sheet during the third quarter of 1994. During 1995, it more than doubled to Y 111 billion by year end, the increase being equivalent to over 60 percent of the increase in gross PBC claims on DMBs and to nearly a fifth of the increase in reserve money. Some of the increase in OIN was believed to be on account of statistical adjustments, including a (downward) revision to the data on the renminbi-equivalent of NFA that was equivalent to a third of the increase in OIN during 1995. Some was on account of credit extended to policy banks through purchase of their bonds with such transactions, being without precedent, recorded as OIN rather than as credit to the financial sector. 3/ The remainder was unexplained but may have reflected credit decisions of local PBC branches and cooperation with local state-bank branches and local administrations. 4/

3. Operatoin of the banking system

Apart from the PBC, the banking system in China consists of the 4 specialized banks (or state commercial banks), 4 universal batiks (or nationwide commercial banks), and 8 other commercial banks. 5/ In addition, three policy banks, intended to take over from the specialized banks the responsibility for much of the policy lending by the banking sector, were established in 1994. 1/ Besides these, there is a network of about 53,000 rural credit cooperatives (RCCs) and 4,000 urban credit cooperatives (UCCs). The commercial banks, together with the RCCs and UCCs, the Agricultural Development Bank of China (ADBC, a policy bank), 2/ and the finance companies are together classified as “deposit-money banks” (DMBs) (Appendix Tables 30 through 33); their consolidated accounts are combined with the PBC’s to produce the monetary survey. 3/ There are a number of smaller deposit-taking institutions—called “nonmonetary financial institutions”—whose accounts are consolidated with the monetary survey to produce a banking survey (Appendix Tables 34 and 35). China’s first privately-owned bank, the China Minsheng Bank, was established in January 1996; it is a joint-stock bank, with the bulk of its shares held by non-state enterprises. Foreign and joint-venture banks have established more than 300 representative offices in China, which engaged almost entirely in foreign currency operations. Finally, there is a large and growing network of nonbank financial intermediaries, including trust and investment companies and finance leasing companies.

a. Commercial banks

During the period after 1993, the operations of the banking system were marked by a move toward greater autonomy of the commercial banks, including through reduction in the scope of the credit plan, more freedom from obligations to make policy loans, and a stronger legal framework. 4/ The banks other than the specialized and universal banks which had hitherto been subject to the credit plan were subject to asset-liability ratios. Banks were given greater freedom in making working-capital loans, and, while they were required to comply with the dictates of the credit plan in making fixed-asset loans, were given the right of project appraisal (leading in some cases to refusal) and were allowed to choose among the fixed-asset projects specified by the credit plan. There was some separation between policy-based and commercial lending, through creation of three policy banks (discussed below). The legal foundation for commercial banks was made firmer through passage of financial legislation, including the Commercial Bank Law. 1/ The Law, passed in June 1995, strengthened the legal framework for banking operations by codifying the nature, organizational structure, and scale of business of commercial banks. 2/ Commercial banks were given greater responsibility for their own profits and losses and were subject to prudential ratios and other international standards under the supervision of the PBC. An important aspect of the Law included separation of banking and nonbanking activities, with commercial banks no longer allowed to invest in nonbank financial institutions.



Citation: IMF Staff Country Reports 1996, 040; 10.5089/9781451807721.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.

There are concerns about the profitability of the specialized banks. These stem from banks’ heavy tax burden of the large stock of nonperforming loans in banks’ portfolios, low interest-rate spreads, and difficulties with transferring outstanding stocks of policy loans to policy banks. Income tax is levied at the rate of 55 percent on domestic banks, compared with a standard rate of 33 percent on domestic and foreign enterprises and of 15 percent on foreign banks. As of September 1995, it was estimated that 20–30 percent of the total loan portfolio of specialized banks consisted of nonperforming loans (comprising bad, or irrecoverable, loans and overdue loans). Of this, 2 percent was estimated to be bad debt, with a further 7 percent being debt that had been overdue for more than three years and may turn out to be irrecoverable. The margins on lending rates, while not negative, were very small. The weighted average lending rate was officially estimated at 12 percent, while the deposit rate (excluding the inflation subsidy) was 9–10 percent; however, once the subsidy was taken into account virtually no margin remained. 3/ The transfer of policy loans from the specialized banks to the policy banks had turned out to be administratively complicated, it being often difficult to distinguish between policy and non-policy components in the outstanding stocks of bank loans. As a result, specialized banks still retained a significant amount of policy loans in their portfolios.

An important concern regarding the banking system was the increase in credit outside the credit plan. The leakages occurred in part through lending by the state banks to other financial institutions through the interbank markets to circumvent the limits under the credit plan and to take advantage of market interest rates. In 1993, state banks had circumvented the credit plan by lending through their nonbank financial subsidiaries.

The practice was curtailed in mid-1993, and restrictions were at the same tine placed on nonbank financial intermediaries’ participation in the interbank markets, but there were reports of it having bean resumed subsequently. In 1995, the Commercial Bank Law provided a legal separation between the activities of bank and of nonbank financial institutions.

A related issue concerns movements in unidentified “other items, net” of the banking system. Other items net, which declined during 1994, increased sharply during most of 1995 before moderating during the fourth quarter. 1/ In 1994, OIN declined by Y 100 billion, as the increase in OIN of the PBC (Y 50 billion) was more than offset by a decline in that of the DKBs (Y 150 billion). In 1995, however, total OIN rose sharply as the increase in OIN of PBC was reinforced by a strong increase in that of banks. During the first three quarters of 1995, the increase in total OIN was equivalent to 80 percent of the increase in domestic credit and to 44 percent of the increase in broad money. During the year as a whole, it amounted to 25 percent and 19 percent of the increase in credit and broad money, respectively.

The changes in OIN were in part the result of statistical factors, but may mostly have reflected misclassified credit. 2/ While the authorities are still in the process of clarifying this item, preliminary indications suggest that several credit items may, in practice, have been were classified as OIN. Some of these credit items include the following: (i) in 1995, a small amount of loans from financial institutions to enterprises were made using “discount loans” and repurchase agreements, considered new financial instruments, which were classified as OIN rather than domestic credit, (ii) In 1995, there was an increase in ‘entrusted’ borrowing (i.e., borrowing that is entrusted to a bank by a particular government agency as a way of borrowing from abroad for special projects) by banks of Y 54 billion, equivalent to about 20 percent of the increase in OIN. For all such borrowings, there are counterpart foreign-currency loans, but since only renminbi-denominated loans are included in the monetary survey, the counterparts to entrusted borrowing are classified under OIN. (iii) DMBs were required to buy financial bonds—equivalent to 9 percent of the increase in OIN during January-September 1995—issued by the three recently-created policy banks; these purchases were not recorded as securities purchases (perhaps because they involved a new financial instrument) but as OIN. (iv) Some DMB branches are believed to have ‘internal’ (i.e., unauthorized and unmonitored) accounts, through which credit ceilings can be evaded.

A puzzling development during 1994–95 concerned the deposit money banks’ NFA, whose movements were difficult to reconcile with developments in the external sector. In the first quarter of 1994, there was a nearly ninefold increase in NFA (to Y 113 billion), followed by wide fluctuations ending in a negative Y 30 billion position by end-1995 (Appendix Table 30). The decline in NFA between March 1994 and December 1995 was mainly on account of an increase in foreign liabilities, and to a lesser extent due to a reduction in foreign assets (Appendix Table 31). 1/ Foreign liabilities of DMBs rose by nearly 40 percent, chiefly due to an increase in entrusted borrowing; there was also an increase in external banks’ deposits with DMBs. Foreign assets declined slightly, mainly due to a decline in foreign securities held by DMBs. At an aggregate level, the decline in NFA was difficult to reconcile with other economic information, notably the balance of payments (BOP) statistics. In particular, the BOP data indicated a sharp rise in negative errors and omissions in the external sector accounts, suggesting the possibility of a rise (rather than a fall) in unidentified purchases of foreign assets by banks.

b. Policy banks

The three policy banks—the Agricultural Development Bank of China (ADBC), the Import and Export Bank of China (IEB), and the State Development Bank (SDB)—were established in 1994, with a view to assuming the responsibility for most policy lending and to give specialized banks more scope for commercial operations. 2/ There has been limited progress with transferring the outstanding stock of policy loans from the specialized banks to the policy banks. The policy banks have, however, begun to make some policy loans. They are mainly financed through bonds sold to the specialized banks 3/, paid-in capital from the state budget, and, when faced with shortages of working capital, through short-term credit from the PBC.

The policy banks have responsibilities in different areas. The ADBC’s loans are mainly for: (i) building national reserves of key agricultural products, (ii) transportation and marketing of grain, cotton, and edible oil, (iii) building national reserves of fleece, cotton, and tobacco, and (iv) poverty alleviation and agricultural development. By September 1995, the outstanding stock of loans was Y 383 billion, most of which (Y 358 billion) comprised short-term lending, which was used primarily for procurement of grain and oil. In practice, financing was provided mainly by the PBC.

The loans of the SDB are allocated mainly to high-technology projects, “pillar” industries, and “bottleneck” industries. 1/ By September 1995, the outstanding stock of loans was Y 138 billion, all of which comprised medium- and long-term credit. The main source of financing was bonds; there was no direct borrowing from the PBC. 2/ The maturities of the bonds issued were relatively short, with 70 percent of the issue comprising three-year bonds, compared with maturities of the loans.

The main function of the IEB is to extend credit for the export of machinery and electronic products, capital equipment, and other capital goods. In 1995, it was also given responsibility for onlending of loans from foreign governments to the Chinese government, and for handling China’s concessional loans and its aid to foreign governments. By September 1995, the outstanding stock of loans was Y 6 billion, all of which comprised medium- and long-term credit. The main source of financing was bonds; there was limited borrowing from the PBC during the early part of the year, mainly to cover liquidity shortages resulting from the requirement that the IEB’s bonds not be issued until after the main Treasury bond issue was completed.

4. Interest rates

The interest rate structure in China is complex, with more than 50 administered rates. 3/ Lending rates are different for fixed asset and working capital loans, and vary by maturity, with maturities being considered in five categories (Appendix Table 36). In addition, rates vary among industrial and commercial loans, agricultural loans, and household loans. While banks are not allowed to apply interest-rate margins on fixed asset loans, a margin of 20 percent is allowed on working capital loans. 4/ 5/ Lending rates to the private sector are freely determined. Deposit rates are different for individual and institutional deposits, and vary by maturity, with maturities being considered in seven categories (Appendix Table 37). 1/ Banks are not allowed to apply interest-rate margins to deposit rates. 2/

Bank interest rates were raised four times during the 1993–95 period but by small amounts. In 1993, rates were raised twice. The average deposit interest rate was raised by about 2 1/2 percentage points in 1993. At end-1993, the rate on one-year time deposits was 11 percent, an increase of about 3 1/2 percentage points since 1992. Although deposit rates were not subsequently changed, the inflation subsidy on deposits of more than three years’ maturity was periodically raised, standing at about 13 percent at end-1995. Protection of these deposits from negative real rates of return helped to bring about a return of household financial savings to the formal banking system. The average lending rate was raised by about 2 1/4 percentage points in 1993. At end-1993, rates on one-year working capital and fixed-asset loans were 11 percent, an increase of about 2 1/2 percentage points since 1992. In 1995, the rate on working capital loans was raised further by about 1 percentage point, and that on fixed-asset loans by about 1 1/4 points. Rates on PBC loans to specialized banks were raised by 3 1/2 percentage points in 1993, and by a 1/2 percentage point in 1995. Rates on Treasury bonds were also raised in 1993; although rates were not increased subsequently, from 1994 the bulk of the Treasury bonds issued carried an inflation subsidy.

III. Fiscal Developments

1. General government operations

Fiscal developments in China during the last decade have been characterized by a broadly unchanged deficit, of about 2 percent of GDP on the state budget, 3/ despitethe economic cycles during this period. However, this relatively favorable picture had masked underlying pressures stemming from ongoing weaknesses in tax revenue. A significant secular decline in the tax ratio—mainlyowing to continuing tax concessions and exemptions as well as problems in tax administration—has necessitated a corresponding compression in budgetary expenditures. 4/ In recent years, this compression has led to both a reduction in the overall level of budgetary spending in terms of GDP and its diversion to off-budget sources. The former has included cutbacks in budgetary subsidies and capital outlays, while the latter has been reflected in a shift of expenditures off budget, largely financed by extrabudgetary revenues (discussed in Section e below) of local authorities as veil as quasi - fiscal operations undertaken by the banking system.

a. Overall budgetary developments in 1994 and 1995

The overall deficit on the state budget in 1994 was targeted at Y 85 billion, or about 2 percent of GDP, broadly unchanged from 1993, with revenue and expenditure targeted at 12.3 percent and 14.3 percent, respectively (see Table 11). 1/ The outcome of Y 74 billion (1.6 percent of GDP) was better than anticipated, in part owing to some improvements in revenue performance following the 1994 tax reform. A similar pattern was observed for 1995: at Y 101 billion, the deficit was budgeted at a level equivalent to 1.8 percent of GDP, and the actual outcome was estimated to be about Y 96 billion, or 1.7 percent of GDP. In 1994–95, both revenue and expenditure were in excess of their respective budgeted amounts, mainly reflecting the conservative nature of budget projections.

Table 11.

China: State Budgetary Operations. 1990–95 1/

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Sources: Data provided by the Chinese authorities; and staff estimates.

These budgetary statistics represent a consolidation of the budget of the central government, provinces, municipalities, and counties. Intergovernmental transfers are netted out. Extrabudgetary financial operations of the various levels of government are not included. Seignorage revenues are not reflected in the budget. Staff estimates indicate that they averaged, during the last ten years, about 2 1/2 percent of GDP, similar to World Bank estimates.

Comprises price subsidies on daily living necessities and agricultural inputs, plus subsidies to cover operating losses of state enterprises.

Change in gross credit to Government less change in treasury deposits at the FBC.

Foreign borrowing by the Ministry of Finance, including all official loans, deferred payments, energy credits, and buyers’ credits.

Policy lending is estimated as the share of lending by the FBC and deposit money banks which has a significant policy content.

b. Revenue

The long-term decline in revenues continued in 1994 and 1995 (Appendix Table 38). Over the 1990–94 period, total budgetary revenue as a percentage of GDP declined steadily from 19 percent to about 12 percent. The early indications of some slowing in the decline in the revenue ratio in 1995 could be attributed in part to the lagged impact of the 1994 tax reform (discussed below) and the ongoing efforts to improve tax administration. As taxes constitute about 93 percent of total state budget revenues, developments in overall revenues reflect mainly those in tax collections.

The secular weakening in revenue performance was reflected across all the main groups of taxes. Taxes on income and profits, of which about 65 percent constitutes taxes on SOEs, fell from 4.6 percent of GDP in 1990 to about 2 percent of GDP in 1994 and 1995. Accounting for only 15 percent of total income taxes, taxes on personal income have continued to play a modest role and have contributed to the low revenue buoyancy of this group of taxes. The low volume of revenue raised from the personal income tax is mainly the result of a narrow base combined with a very high tax threshold. As for the enterprise income tax, the continued fall in the ratio to GDP—from 4 percent in 1990 to an estimated 1.5 percent in 1995–reflects the combined impact of the relative decline of the SOE sector and a number of tax incentives that have exempted a significant share of the income of the nonstate sector from taxation. Exemptions and tax holidays accorded to the most dynamic segments of industry and trade, in particular foreign-funded enterprises, are an important reason for the low overall buoyancy of the present tax system. A large decline has also taken place in the category of “other taxes” (including a number of earmarked taxes, see Appendix Table 38) from about 2.7 percent of GDP in 1990 to about 1 percent of GDP in 1994–95.

Consumption taxes (comprising mainly the value-added tax, excises, and the business tax), which constitute the main source of revenue in China, have shown a comparatively modest decline, from slightly less than 9 percent of GDP in 1990 to 7.7 percent in 1994 and 1995. 1/ Value-added tax (VAT) revenues represent the largest source of consumption taxes, accounting for almost two thirds of the total, about 5 percent of GDP, and more than 40 percent of total revenue (see below). In large part, this strong performance is the result of the 1994 tax reform that broadened the VAT base by consolidating a number of excises and business taxes in the VAT. Notwithstanding the overall success in implementing the new VAT, there has been a buildup of arrears on export VAT refunds (of more than Y 40 billion) at the end of 1995, a problem related to the VAT refund rate (see Section f below).

Customs duties have made only a small contribution to revenues—having stabilized at about 1/2 percent of GDP in 1994–95, compared with about 1 percent at the beginning of the decade. Reflecting the numerous duty exemptions offered to foreign and domestic enterprises, the effective tariff rate (defined as tariff revenue as a percent of imports) is estimated at less than 5 percent in recent years compared with an average (unweighted) nominal tariff rate of about 36 percent. 2/

Developments in the Tax Structure, 1990–95

(In percent of total revenue)

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Sources: Data provided by the Chinese authorities; and staff estiou Note: The table refers to revenues of the State budget only.


These revenue trends have reinforced the reliance on consumption in the state budget (amounting to about two thirds of total taxes), a feature that distinguishes China from most other developing countries countries in transition (see below).

The Tax Structure in Selected Countries 1/

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Source: Staff estimates.

Revenues reported in this table include, in addition to budgetary revenue, the estimated revenues accruing to the extrabudgetary social funds but not other extrabudgetary funds, see Section e below.

Implementation of planned tax policy measures (which were to be announced in early 1996 along with the 1996 budget), including a considerable strengthening of the personal income tax, reductions in import duty exemptions, and a gradual repeal of tax holidays and other tax concessions in the enterprise income tax, should help broaden the tax base and improve its tax-revenue buoyancy.

c. Expenditure

Since mid-1992, expenditures of the central and local governments have been strictly curtailed, mainly in response to the ongoing weakness in fiscal revenues. Thus, expenditure as a share of GDP declined from more than 20 percent in 1990 to about 14 percent of GDP in 1994 and fell slightly further in 1995 (Appendix Table 39). As noted earlier, while including cutbacks in budgetary subsidies, the brunt of the reduction in spending fell on social and physical infrastructure.

The reduction in the share of capital expenditures in GDP was accompanied by a significant change in their structure. The share of such outlays in total expenditure was reduced from over 20 percent at the beginning of the 1990s to about 15–16 percent in both 1994 and 1995. At the same time, the composition of capital outlays changed, with expenditures on basic capital construction or infrastructure investment declining relative to those on investments in the productive capacity of enterprises (which increased from less than 10 percent of total capital expenditures in 1990 to more than one third in 1995). As a result, public infrastructure investment measured as a share of GDP fell to about a third of the 1990 level.

An even larger change occurred with regard to budgetary subsidies. Which are provided to cover operating losses of SOEs and to provide support for daily living necessities and agricultural inputs, mainly for social purposes (Appendix Tables 39 and 40). 1/ Such subsidies were cut from more than a quarter of total budgetary outlays in 1990 (or more than 5 percent of GDP), to about 11 percent in 1994, and further to an estimated 9 percent in 1995 (about 1 1/2 percent of GDP). The largest cuts were made in subsidies to cover SOE losses, which constitute about 44 percent of total subsidies in 1995, down from 60 percent in 1990. These developments may, however, understate the total amount of budgetary subsidies provided to SOEs, as subsidies are also granted implicitly through the tax system, by way of negotiated tax payments or tax refunds for specific enterprises. Lack of data prevents a more detailed analysis of the level and trends of such payments or refunds.

Although no official information is available regarding the breakdown of expenditure by economic classification, it is estimated that wages and salaries account for about 25–30 percent of total expenditure. The absence of an automatic wage indexation mechanism, with the fixed salary schedule providing for wage increases only in connection with promotions, has helped prevent significant increases in this component of spending. Although adequate information is not available on the changes in the number of public employees, the absence of indexation and the strict control and reduction of employment in the central government, in particular in the context of the recent civil service reform (see Chapter I), have facilitated tight control of this category of current expenditure.

Interest expenditures increased in recent years, albeit from a low level, following the decision in 1994 terminating central bank lending to the Government (in all but exceptional circumstances) and the increased reliance for deficit financing on bond issues. Accordingly, expenditure on interest payments increased from about 0.2 percent of GDF in 1990 to an estimated 0.5 percent of GDF in 1995.

d. Financing

In the recent past, Treasury bonds, the outstanding stock of which was Y 330 billion (equivalent to 6 percent of GDP) at end-1995, were issued mainly through mandatory placements with enterprises, households, and financial institutions, but a number of initiatives (e.g., increases in interest rates and introduction of an inflation subsidy as well as shortening of the maturity structure) made government debt instruments more attractive, and bond placements during 1994 and 1995 were successful. During 1995, gross central government bond issues amounted to about Y 153 billion, of which about Y 67 billion were used to finance the deficit, and the remainder to refinance or existing debt and to pay interest 1/ (Appendix Tables 4142).

e. Extrabudyetarv fiscal operations

Relatively limited information is available on the five extrabudgetary social funds (the pension fund, the unemployment fund, the medical fund, the injury fund, and the maternity fund), which at present are financed primarily by employers’ payroll contributions, and with coverage broadly confined to the SOE sector. In 1994, the pension fund had combined revenues of about Y 68 billion, or 1 1/2 percent of GDP; it posted a small cash surplus of 0.1 percent of GDP in both 1994 and 1995. With about Y 2.5 billion in revenues, the unemployment fund is much smaller. This fund also ran a small surplus in 1994 and 1995. Financial data are not available for the remaining (even smaller) social funds that were established fairly recently, but which are also believed to have operated modest surpluses.

Other extrabudgetary funds, the number of which is estimated to exceed 1,000 and which comprise funds established primarily at the provincial and local government levels, are financed by a variety of surcharges and taxes, earmarked to support mainly capital investment projects. The funds had combined revenues in 1995 broadly estimated at Y 200 billion, or 3.7 percent of GDP, and ran a surplus estimated at about 0.3 percent of GDP. The Government intends to strengthen control on extrabudgetary fiscal operations, partly by establishing an improved recording system, with the objective of gradually shifting these activities to the budget.

In addition to these extrabudgetary fiscal activities, significant quasi-fiscal operations take place through so-called policy lending of the banking sector to SOEs, including to loss-making SOEs. The fiscal significance of this type of activity should ideally be measured on the basis of the overall extra costs (including revenue losses) imposed on enterprises by government policies, but estimates of these costs are not available. One possibility of estimating a broader fiscal deficit would be to include a measure of total SOE losses, not financed by budgetary subsidies. This would add another 1.3 percent of GDP to the deficit in 1994, and an estimated 1 percent of GDP in 1995. Together with the extrabudgetary activities described above, this would yield a broad deficit measure of about 2 1/2 percent of GDP in both 1994 and 1995.

An alternative measure of the broader fiscal deficit measure would include an estimate of total policy lending from the banking sector, representing lending undertaken by the banks at the state’s behest in support of specific policies, notably for key state projects, agricultural procurement and development, and trade financing. 1/ These lending operations, which have a significant fiscal content, could add another 5–6 percent of GDP to the budget deficits in 1994 and 1995, resulting in consolidated deficits of around 6 1/2–7 1/2 percent of GDP in both years. These estimates should be interpreted with caution, however, in view of the significant conceptual and statistical problems associated with measures of policy lending. Partly to address these difficulties, the World Bank has estimated an even broader “deficit” measure by consolidating the balance of the Government and SOE sectors in a measure of the public sector borrowing requirement which shows a decline in recent years owing to a small reduction in investments by SOEs and an, as yet unexplained, large increase in SOE deposits with the banking system. 2/ It may be reasonably concluded on the basis of the data available that the small state budget deficit significantly underestimates the impact on the economy of current fiscal operations, as well as the magnitude of these operations.

f. Tax reform

The year 1995 saw the further implementation of the 1994 tax reform, which had introduced a unified tax code and a simplified and modern tax system, more in line with the requirements of a market-based economy. 1/ The basic objectives of the reforms were to improve revenue buoyancy and transparency, by relying less on ad hoc negotiated tax payments, and by standardizing the tax treatment of different enterprises. The income tax treatment of different types of domestic enterprises (SOEs, collectives, private enterprises) was unified, at a standard tax rate of 33 percent, and with standardized tax allowances. A new personal income tax was applied to both Chinese and foreign individuals thus replacing the two different types of individual income taxas that had been in place. A broad based and greatly simplified VAT, with a standard rate of 17 percent, was also introduced. The new system was supported by a reform of the tax administration, which was split into a National Tax Service and local tax services, to collect central and local taxes, respectively.

The main tax policy measure implemented during 1995 was the reduction in the refund rate for VAT on exports effective July 1, from 17 percent (the standard rate, given that exports are zero–rated) to 14 percent, followed by a further reduction to only 9 percent as of January 1, 1996. The departure from the standard practice of zero-rating exports was implemented to address the authorities’ concern of the high level of rebates, taking into account the fact that processing trade was exempt from VAT. Furthermore, refunds of VAT on exports exceeded the associated revenue collected on exported goods, owing possibly to fraudulent claims for export refunds.

g. Intergovernmental fiscal relations

Contemporaneously with the tax reform mentioned above, a major reform was implemented in 1994 of the system of intergovernmental fiscal relations, including the system of tax assignment, tax sharing arrangements, and transfers. 2/ The new system was to replace the complex contract-based intergovernmental revenue system, and was intended to be more transparent, to restore a larger degree of central government control over revenues, and to strengthen fiscal policy as an instrument for macroeconomic management. The basic principles of the new system were kept unchanged in 1995, and the phasing-in of the new sharing system continued.

Following this reform, the central government has been assigned the revenues from the enterprise income tax on centrally owned SOEs; the business tax on railways and the financial sector; the excise tax; customs duties; and VAT on imports. Local governments are assigned revenues from the enterprise income tax on all enterprises that are not centrally owned; personal and agricultural income taxes; the business tax (apart from railways and the financial sector); land use and stamp taxes; and several minor transactions taxes and charges. The VAT is shared between the central and local governments, with 75 percent accruing to the former and 25 percent to the latter. A key objective of the reform was to raise the central government’s share in total revenue (before transfers) to 60 percent over the medium term, and significant progress was made in 1994–95 in raising this share, although it remained below the target (Appendix Table 43). While the reform resulted in the emergence of a budgetary surplus at the central government level, pending reform of the grants mechanism, a large portion of the surplus was transferred back to local governments.

The transfer system (which still—but to a more limited degree than previously—relies on negotiated transfers between the center and the regions) continues to be based on the “basic amount principle” according to which revenue of individual regions cannot fall below a basic amount, (set as equal to actual 1993 revenue).

The present system has not addressed fully the important problem of the widening economic disparities between different regions. A satisfactory solution to this problem would—inter alia—require the introduction of a grant system, based on equalization of objective expenditure needs and revenue capacities across regions. Preparatory work has been initiated.

IV. External Sector Developments

1. Overview

The most notable external development in the last two years has been the strength of China’s balance of payments and the associated rapid buildup in international reserves. This outcome reflected a marked turnaround in the trade account from the deficit in 1993, as well as the large inflows of foreign direct investment. More recently, however, the strength in the external sector has begun to dissipate as suggested by the slowing in the pace of export growth during the course of 1995. At the same time, unrecorded transactions in the balance of payments have increased sharply, reflected in a significant rise in “errors and omissions” in 1995. In other external developments, the renminbi has moved within a narrow range relative to the U.S. dollar since the exchange market unification in January 1994. The real effective exchange rate, however, appreciated during this period mainly as a result of higher inflation in China relative to its trading partners.

2. Merchandise trade

Following a deficit of almost $11 billion in 1993, China’s merchandise trade account shifted into a surplus of $7.3 billion in 1994, which rose to over $17 billion in 1995 (Table 12 and Appendix Table 44). The turnaround reflected very strong growth in merchandise exports and relatively subdued import growth, especially during 1994. China’s terms of trade improved slightly in 1994, but remained unchanged in 1995 (Table 13).

Table 12.

China: Balance of Payments, 1990–95 1/

(In billions of U.S. dollars)

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Sources: Data providad by tbe Chinese authorities; and staff estimates.

Data for 1992–95 are not comparable with data for earlier periods, owing to extensive data revisions. The most substantial changes have occurred in services and short-term capital.

Excludes errors and omissions.

Sines 1992, the authorities bava reported official reserves on a narrower basis, including only the foreign assets of the People’s Bank of China and excluding assets held by the Bank of China and other specialized banks. Thus, since 1992, the net foreign asset transactions of the specialised banks have been reclassified under other net transactions.

A minus sign indicates an increase.

Table 13.

China: Selected Indicators of Merchandise Trade, 1988–95

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Sources: Data provided by the Chinese authorities; and staff estimates.

On a balance of payments basis.

Based on staff estimates.

Percentage change in constant dollar imports divided by the percentage change in real GFP.