China
Recent Economic Developments
Author:
International Monetary Fund
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Publication Date:
08 Sep 1997
eISBN:
9781451807738
Language:
English
Keywords:
ISCR; CR; exchange rate; broad money; retail price index; People's Bank of China; foreign direct investment; current account; narrow money; retained earnings; personal income; trade balance
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This paper describes economic developments in the People’s Republic of China during 1996–97. In 1996, the authorities succeeded in stabilizing growth at a high level while alleviating the inflation pressures that had characterized the 1993–94 boom. From an average rate of more than 13 percent in 1992–94, real GDP growth eased to 10.5 percent in 1995 and further to 9.7 percent in 1996, reflecting moderation in the aggregate demand components, notably fixed investment. The sectoral real GDP growth pattern in 1996 was broadly unchanged from the first half of the decade.

Abstract

This paper describes economic developments in the People’s Republic of China during 1996–97. In 1996, the authorities succeeded in stabilizing growth at a high level while alleviating the inflation pressures that had characterized the 1993–94 boom. From an average rate of more than 13 percent in 1992–94, real GDP growth eased to 10.5 percent in 1995 and further to 9.7 percent in 1996, reflecting moderation in the aggregate demand components, notably fixed investment. The sectoral real GDP growth pattern in 1996 was broadly unchanged from the first half of the decade.

I. Output and Price Developments

A. Introduction

1. In 1996 the authorities succeeded in stabilizing growth at a high level while alleviating the inflationary pressures which had characterized the 1993–94 boom. From an average rate of over 13 percent in 1992–94, real GDP growth eased to 10.5 percent in 1995 and further to 9.7 percent in 1996, reflecting moderation in the aggregate demand components, notably fixed investment. The sectoral real GDP growth pattern in 1996 was broadly unchanged from the first half of the decade, with continued moderate growth in agriculture and services and more rapid increases in industrial production (Table 1).

Table 1.

China: GDP by Sector, 1991–96

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Source: State Statistical Bureau (SSB), China: Statistical Yearbooks.

2. As in past years, the growth of value-added in the nonstate sector in 1996 was much higher than in state-owned enterprises (SOEs). Domestic collective and private industrial enterprises continued to record real growth rates in excess of 20 percent. Foreign-funded and Sino-foreign joint ventures showed similar growth rates, representing a moderation from the very rapid pace of previous years, which had reflected strong expansion of their productive capacity from a low base. Meanwhile, state-owned industry showed signs of weakness in 1995 and 1996, with declining profits, a rise in the number of loss-making enterprises, and sharp decreases in capacity utilization in a number of industries.2

B. Demand Developments

3. Demand developments in 1996 were characterized by continued but moderate restraint in fixed-asset investment and a further slowdown in nominal consumption (Table 2). Notwithstanding a further slowing in nominal terms, however, the growth of fixed-investment spending appears to have increased somewhat in real terms.3 A sharp slowing of nominal-consumption spending suggests that real-consumption growth declined slightly from 1995.4 Net exports as a share of GDP weakened in 1996,5 mainly as a result of the reduction in the value-added tax (VAT) rebate and continued real exchange rate appreciation. While complete firm-level reporting data are not yet available, staff estimates suggest a relatively sharp increase in stock accumulation in 1996 compared to the previous year.

Table 2.

China: GDP and Expenditure Components, 1991–96

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Sources: State Statistical Bureau; and staff estimates.

Goods and nonfactor services.

Staff estimates; the consumption and saving ratios are derived using the total investment ratio and net exports (for consumption) or the current account balance (for saving). As a result, consumption and saving include the statistical discrepancy between production-based and expenditure-based measures of gross domestic product.

Investment

4. As in previous years, policies affecting fixed investment—control of investment approvals and bank credit—remained at the core of macroeconomic policy. Notwithstanding continued moderately restrained policies, nominal fixed investment in 1996 decelerated somewhat less than nominal GDP, raising the fixed investment-to-GDP ratio slightly. In state-owned units, investment financing grew proportionally across most funding sources (Table 3). The majority of fixed-asset investment continued to be financed through retained earnings and local extrabudgetary operations.6

Table 3.

China: Investment in Fixed Assets by State-Owned Units, 1991–96

(In billions of yuan)

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Source: State Statistical Bureau.

As reported by the SSB; sum of components may not be equal to total due to rounding.

5. The composition of fixed investment by state-owned units (SOUs)7 in 1996 broadly reflected the priorities in the Ninth Five-Year Plan (1996–2000). SOU investment expenditure grew strongly in energy production and transportation (Table 4), while investment in nonenergy industrial sectors (and, particularly, in industries characterized by excess capacity, such as textiles and certain consumer goods industries) was scaled back. Real estate investment—which had been a source of demand pressure in previous years—picked up in 1996 after decelerating in the preceding two years (Table 5). Investment growth was concentrated in the coastal regions, particularly the Shanghai and Guangdong areas, while fixed investment spending in the central and western provinces declined (Table 6).

Table 4.

China: Capital Construction of State-Owned Units, 1991–96

(In billions of yuan)

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Sources: China Statistical Yearbook; China Monthly Statistics; and China Economic Developments.
Table 5.

China: Total Fixed-Asset Investment, 1991–96

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Sources: Data provided by the State Statistical Bureau; and staff estimates.
Table 6.

China: Investment by State-Owned Units by Region, 1991–96 1/

(In billions of yuan)

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Source: Data provided by the State Statistical Bureau.

Data not available for all areas. Total may not equal sum of areas.

6. Inventory accumulation is estimated to have increased in 1996, after relatively large increases in 1995. As in the previous year, the buildup was in part due to increased state grain purchases following a favorable harvest. In addition, there have been reports of rising inventories of consumer goods, especially in the textile, automobile, and consumer durables industries. These stocks are believed to reflect slower growth in export markets, overproduction in SOEs facing increased competition from nonstate and foreign-funded enterprises, as well as large capacity increases during the 1992–93 investment boom.8

Consumption

7. Nominal consumption expenditure (including public consumption) in 1996 is estimated to have decelerated more than the reduction in inflation, suggesting a slowdown in real terms compared to 1995. The rate of growth of consumption, however, was in line with nominal per capita incomes (Table 7), particularly in rural areas. Meanwhile, nominal retail sales continued to grow briskly (Table 8).

Table 7.

China: Annual Income and Expenditure in Urban and Rural Areas, 1991–96

(In yuan per person)

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Source: State Statistical Bureau.
Table 8.

China: Retail Sales, 1991–96

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Source: State Statistical Bureau.

Includes sales to nonagricultural residents; excludes market sales to rural residents; includes means of agricultural production before 1993.

With less than seven employees.

Domestic enterprises only.

Consists of: retail sales by farmers to nonagricultural residents; individual outlets with more than seven employees; shareholder enterprises; joint ventures; Hong Kong, Macao and Taiwan Province of China funded enterprises.

8. As shown in Table 7, urban residents recorded continued strong increases in food expenditure, as well as in spending on cultural activities and housing. Rural residents reported rising expenditure primarily in food and clothing.

C. Production Developments

Industry and construction

9. Growth in industrial value added slowed in 1996, continuing the moderation from the “overheated” rates in 1992–94;9 this occurred despite a slight acceleration of gross industrial production (Table 9). SOE industrial production continued to grow at a much slower pace than nonstate enterprises and the share of the state sector in industrial production declined further. There was a marked slowdown of production growth in private, foreign-funded and joint-venture enterprises, reflecting primarily a moderation after the very rapid increases from a low base at the beginning of the decade.

Table 9.

China: Industrial Production, 1991–96

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Source: Data provided by the Chinese authorities; and China Statistical Yearbook.

10. Production of many consumer goods such as bicycles, sewing machines, televisions and radios declined in 1996 (Table 9). In addition, due in part to cotton price increases and weak textile exports, cloth and yarn production decreased, as did output of chemical fibers. In addition, these sectors recorded substantial declines in capacity utilization, while overcapacity and growing stocks also affected motor vehicles production. Reflecting the investment priorities in the Ninth Five-Year Plan, strong production increases were recorded in chemical and petroleum products and high-technology products such as microprocessors.

11. Growth of real value added in the construction sector slowed substantially further from its highs in 1992, despite the relative recovery in real estate investment and in other investment categories.

Agriculture

12. Growth in real value added in agriculture picked up in 1996, exceeding the average rate of the first half of the decade. Contributing factors included a record grain harvest and a rise in the relative proportion of agricultural land, as well as procurement price increases in recent years. Meat and aquatic goods production recorded continued strong increases, while production of cotton and oil-bearing crops fell (Table 10).

Table 10.

China: Agricultural Output, 1991–96 1/

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Source: State Statistical Bureau.

Excluding village-run industries.

Grain equivalent (5 kg. of tubers equivalent to 1 kg. of grain).

Services

13. Value added in services continued its deceleration from the double-digit growth rates recorded in 1991 and 1992. Performance in services reflected the increasing importance of the relatively buoyant wholesale and retail trade sectors. Growth in transportation and communications declined vis-à-vis previous years.

D. Income Developments

14. In 1996, urban per capita income increased by 3.8 percent in real terms, outpaced by rural per capita net income, which grew by 9.0 percent (Table 7). As a result, the urban-rural income disparity narrowed for the first time in a decade. As a share of GDP, net personal income reached almost 50 percent in 1996, slightly higher than in 1995 and the highest level since 1991. After adjusting for general government revenues, net profits, interest and other income remained at roughly 40 percent of GDP. The saving rate from personal income of both urban and rural residents rose substantially in 1996, implying much higher saving rates from profit, interest and other income, of the order of 80 percent in 1995 and 1996.10

E. Labor Market Developments

15. The growth of the labor force in 1996 was dominated by increases in the urban labor force (Table 11). With regard to the composition of employment, there was continued movement out of agriculture into services in 1996, with more moderate employment growth in industry and construction. Employment in the services sector increased to one-fourth of the total, while that in industry and construction increased only slightly.11 Within the urban economy, employment in the state-owned sector remained broadly unchanged, with a continued flow into foreign-funded and private firms, and declines in collective employment.

Table 11.

China: Labor Force and Employment, 1991–96

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Sources: State Statistical Bureau, China Statistical Yearbook, issues for 1990–95; and staff estimates.

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

Urban labor force and rural labor force are derived from survey data; urban employment and unemployment data are derived from other sources, so they do not necessarily add up to the figure shown for the urban labor force.

Foreign-funded enterprises.

16. Registered urban unemployment continued to edge up in 1996, reaching 5.5 million—3 percent of the urban labor force. Unregistered unemployment is also estimated to have increased, as formal layoffs over the last few years amounted to nearly 10 million. The effects of layoffs on unemployment, however, have been moderated by success in reemployment efforts (primarily in the more dynamic coastal provinces), although many of the separated workers have not registered with local authorities.12 Unemployment data also do not include many migrants from rural areas in search of work (see below). Finally, there may be as many as 10 million or more workers still on enterprise books working reduced shifts, who are still receiving support or are working with wage payments in arrears.13

17. The authorities have taken steps to facilitate labor mobility, including the introduction of independent medical and unemployment insurance systems in some areas, the creation of retraining and reemployment centers in many cities, and the continued transfer of housing, education, and medical facilities from state enterprises to local governments.

18. Continued productivity increases in agriculture, together with the relatively limited supply of unutilized arable land, have resulted in a surplus rural labor force of 100–130 million.14 As much as ½–⅔ of this surplus is mobile, migrating from low-income to higher-income regions, particularly the larger cities.

F. Prices and Wages

19. Price developments in 1996 were favorable, with a further decline in inflation confirming the successful soft landing. The retail price index (RPI) rose by 6.1 percent in 1996, after increasing by 21.7 percent in 1994 and 14.8 percent in 1995 (Table 12). Both the food and nonfood components of the RPI decelerated in the past two years (Table 13).

Table 12.

China: Prices, 1991–96

(Average annual percent change, unless otherwise indicated)

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Sources: State Statistical Bureau; and Ministry of Internal Trade.

Change measured December on December.

Table 13.

China: Selected Inflation Measures, 1993–96

(Twelve-month percentage change)

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Sources: State Statistical Bureau; and staff estimates.

20. The decline in inflation mainly reflects the moderation of real GDP growth from the unsustainable rates in 1993 and 1994.15 In addition, a record grain harvest contributed to a substantial deceleration of food prices, which make up 40–50 percent of both the cost of living index16 and the RPI. After rising 24.7 percent in 1995, the food component of the RPI increased by 7.7 percent in 1996. The increase in the retail price of grain was only 7.5 percent in 1996, despite increases in grain procurement prices that averaged 42 percent nationwide.17

21. Substantial variation in inflation rates has persisted across regions and price categories. Prices rose faster in rural areas than in urban areas in 1996, and the regional components of the CPI showed substantial dispersion, ranging from a low of 3.9 percent (December-over-December) in the city of Shijiazhuang to a high of 12.4 percent in Guiyang. In addition, prices of service items rose considerably faster than goods prices. As a result, the CPI—which includes an estimated 10 percent share of service items—continued to rise faster than the RPI (Box 1). Some price categories accelerated in early 1996, notably fresh vegetables and aquatic products. Production materials inflation—which has diverged substantially from overall inflation since 1994—picked up temporarily in the first half of 1996.

Measuring inflation in China

A number of price indices are compiled by the State Statistical Bureau, the most important of which are the retail sales price index (RPI), the cost of living index—also referred to as the consumer price index (CPI)—and the CPI of residents in 35 major cities. These indices have shown broadly similar movements over the past few years, although the RPI measure of inflation generally has been lower, reflecting the exclusion of the relatively faster rising prices of services. The discrepancy measured in percentage points has been relatively constant over time (see chart). The category weights in the indices are not published, although it is estimated that food items make up about half of both the CPI and the RPI. The constituent subindices of the indices have diverged in the past, reflecting mostly the different behavior of food and nonfood prices.

  • The RPI includes prices of consumer goods sold at the retail level. In addition to the overall index, sub-indices for a number of food and nonfood categories for urban and rural areas are published monthly on a 12-month-change basis.

  • In contrast to the RPI—which reflects overall retail sales—the CPI reflects a typical consumption basket derived from a consumer survey, and includes service items. It is published monthly on a 12-month-change basis, nationwide and for rural and urban areas. Services are estimated to make up a relatively modest 10 percent of the index, reflecting the fact that many service items—such as housing and health care—are not marketed, but are provided through employees’ places of employment.

  • A subset of the nationwide CPI, the CPI of Residents in 35 Major Cities, is published monthly on a 12-month-change basis, including its constituent subindices by spending category and by city.

uA01fig01

China: Different measures of inflation

(12-month change in index; in percent)

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

22. Although the majority of retail transactions are now conducted at market-determined prices (Box 2 and Table 14), the prices of some 30 items remain under local or central government control. A number of administered price adjustments were made in 1996, including in grain procurement and retail prices, crude oil and refined oil prices, fertilizer prices, and electricity rates. The locally administered rates for public transportation, housing, and water were also increased. Despite the further decline in inflation, the scope of price surveillance was expanded in 1996, with the government intensifying monitoring of price monopolies and excessive profit margins. In addition, a system was introduced under which local governments are responsible for adequate supplies and reasonable price developments in the local grains and vegetables markets, prompting the establishment of price regulation funds for these food items in some areas.

Table 14.

China: Proportion of Agricultural Output, Production Materials and Retail Sales Sold at Fixed, Guided and Market Prices, 1978–95

(In percent)

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Sources: China Price Yearbook, 1990; and data provided by the Chinese authorities.

23. Wage rises moderated in 1996 (Table 15). The average money wage in SOUs rose faster than in collectives and other forms of ownership, as wage reforms focusing on monetizing wages continued—the authorities estimate that 15–17 percent of remuneration in SOUs still consists of nonwage payments, such as subsidized housing, education, health care, and meals. Other reform measures have aimed at improving the wage-setting process and making remuneration more responsive to economic performance. Partly as a result of these efforts, 60 percent of enterprises now tie wages to some measure of economic performance, such as profits, taxes, working hours, and production volumes.

Table 15.

China: Average Money Wage of Formal Employees, 1991–96

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Sources: State Statistical Bureau (SSB), China: Statistical Yearbooks; and SSB, China: Latest Economic Indicators.

Proportion of Retail Sales at Administered and Market Prices

uA01fig02
Source: State Statistical Bureau.1 Includes fixed and guided prices.

II. Monetary and Financial Developments and Policies18

A. Introduction

24. During 1995–96, monetary and credit policies continued to be moderately restrained, contributing to the successful lowering of inflation without a sharp slowing in growth. The wide-ranging structural reform program introduced in 1993 was steadily implemented, with measures to strengthen the role of the central bank, further develop indirect instruments of monetary policy, and increase the market orientation of commercial banks and other financial institutions. The authorities have begun to pay increasing attention to the safety and soundness of the financial system.

B. Money and Credit Developments

25. Money and credit developments in 1995 and 1996 are to be viewed against the background of the authorities’ efforts to restore macroeconomic stability following the intense overheating and disorderly financial conditions of 1993. After some initial faltering, in late 1994 an “appropriately tight” monetary policy was adopted, the main objective of which was to lower inflation by reducing broad-money growth.

26. Broad-money growth slowed gradually, reflecting in part a reintermediation into the banking system of savings deposits which had fled the system during the period of overheating. The slowing was achieved despite a large increase in net foreign assets (NFA) of the banking system that to some extent blunted domestic credit restraint. Broad money growth, while still slightly more rapid than originally intended in 1995, was in line with the authorities’ objective of 25 percent in 1996 (Table 16).19 It remained rapid relative to growth in nominal income, however, with the decline in the income velocity of money in 1996 particularly sharp. While velocity declined by about 3½ percent a year on average (year-on-year basis) during 1985–95, it fell by 8½ percent in 1996. Monetary policy has been implemented against the background of relative stability in the nominal exchange rate of the renminbi (RMB).20

Table 16.

China: Banking Survey, 1993-96 1/

(In billions of yuan, end-of-period basis)

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Source: Data provided by the Chinese authorities.

Includes the operations of the People’s Bank of China, the deposit money banks, and other banks (or specific depository institutions). Data for March 1996 and later include, in addition, operations of two policy banks (the Export-Import Bank and the State Development Bank).

Owing to a break in the series in 1993, growth rates for that year are not available.

Structure of the Banking System

Apart from the PBC, the banking system in China consists of 4 state commercial banks (formerly known as “specialized banks”), four nationwide commercial banks (the former “universal banks”), and eight other commercial banks.1 In addition, three policy banks were established in 1994. Besides these, there is a network of about 53,000 rural credit cooperatives (RCCs), 5,100 urban credit cooperatives (UCCs), and several finance companies, plus a network of non-bank financial intermediaries comprising trust and investment companies (TICs) and finance leasing companies.

The main monetary accounts are the banking survey (Table 16), the operations of the PBC (Table 17), and the monetary survey (Table 18). The commercial banks, together with the RCCs, UCCs, finance companies, and the Agricultural Development Bank of China (the only deposit-taking policy bank) are classified as “deposit-money banks” (Tables 19 and 20). Their domestic-currency accounts are consolidated with the PBC to produce the monetary survey. The monetary survey is combined with the domestic-currency accounts of the TICs, finance leasing companies, and (since March 1996) the remaining two policy banks (all of them for accounting purposes classified as “other banks” (Table 21)) to produce the banking survey. 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. Finally, foreign and joint-venture banks have established more than 300 representative offices in China, engaging almost entirely in foreign-currency operations. The official monetary statistics thus cover only the domestic-currency operations of domestic financial institutions. Foreign-currency operations, as well as the operations of foreign financial institutions, have yet to be integrated into the statistics.

Table 17.

China: Operations of the People’s Bank of China, 1993–96 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.

In November 1996, a strengthening in the enforcement of reserve requirements over rural credit cooperatives was accomodated by an expansion in reserve money. The growth rate of reserve money excluding this operation was just over 20 percent for the year as a whole.

Ratio of broad money, as reported in the banking survey, to reserve money.

Ratio of banks’ excess reserves to deposits as reported in the banking survey.

Table 18.

China: Monetary Survey, 1993–96 1/2/

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Source: People’s Bank of China.

Includes the operations of the People’s Bank of China, specialized 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.

Table 19.

China: Assets and Liabilities of Deposit Money Banks, 1993–96 1/2/

(In billions of yuan, end of period)

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Source: Data provided by the Chinese authorities.

Includes the operations of specialized and universal banks, rural and urban credit cooperatives, and the Agricultural Development Bank.

Based on the new statistical methodology that is used to compile the monetary survey.

In keeping with the authorities’ presentation, “other items, net” is shown as a negative entry on the liabilities side, rather man a positive entry on the assets side, and it does not net out bonds and owners’ equity.

Table 20.

China: Foreign Assets and Liabilities of Deposit Money Banks, 1994–96

(In billions of U.S. dollars)

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Source: Data provided by the Chinese authorities.
Table 21.

China: Assets and Liabilities of Specific Depository Institutions (or “Nonmonetary Financial Institutions”), 1993–96 1/

(In billions of yuan; end of period)

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Source: Data provided by the Chinese authorities.

In keeping with the authorities’ presentation, “other items, net” is shown on the liabilities rather than the assets side and does not net out bonds and owners’ equity.

As regards the relative size of the categories of financial institutions, in 1996 the state commercial banks accounted for roughly two thirds of the stock of bank credit, the RCCs and UCCs for nearly a fifth, and the TICs, finance leasing companies and two policy banks for the remainder.

The main monetary aggregates are broad money, narrow money, currency in circulation, and reserve money. Narrow money comprises currency in circulation and demand deposits; broad money comprises narrow money and longer-term deposits. Since TICs, finance leasing companies, and the above two policy banks take only longer-term deposits, narrow money is identical in the monetary and banking surveys, while broad money is somewhat higher in the banking survey.2

1 See China Financial Outlook 1995 (Beijing: People’s Bank of China, 1995), page 88, for a more detailed list of domestic banks. 2 The growth rates of broad money are similar in the two surveys in most years, however. For 1993 in particular, consistent data for the banking survey are not available and data from the monetary survey have been used.

27. Narrow money growth picked up slightly in 1996, following a sharp deceleration in 1995. In 1996, narrow-money growth rose to 19 percent (from 17 percent in 1995), on account of a small pickup in the growth of demand deposits and currency. Currency growth recovered somewhat in 1996, after falling in 1995 from 24 percent to 8 percent.21 In 1995–96, narrow-money growth was slower than growth in broad money, reflecting the steady reintermediation of saving deposits into the banking system, as well as financial innovations that have helped agents to economize on their narrow-money holdings.22

28. Reintermediation into the banking system has been reflected in a surge in bank deposits, especially longer-term deposits, of enterprises and households.23 The growth in bank deposits is attributable to a number of factors, including greater financial stability, an “inflation subsidy” on savings deposits, and lower inflationary expectations. Unauthorized savings schemes established in 1993—by, for example, SOEs—were progressively dismantled in 1994–95. In response to negative real interest rates, an inflation subsidy on households’ saving deposits of three years’ maturity or longer was introduced in mid–1993 that prevented the real interest rates on these deposits from turning negative.24 In April 1996, when inflation had for several months been below the nominal interest rate, the subsidy was discontinued for new deposits.25 The discontinuation may have contributed to the subsequent slowing in quasi-money growth. In addition, although the subsidy was, in principle, applicable only to households’ deposits, enterprises are reported to have “disguised” their deposits in order to take advantage of the subsidy. Efforts by the authorities to check such practices were strengthened in 1996, perhaps contributing further to the slowing in quasi-money. Finally, moderating inflation may have contributed to lower inflationary expectations and greater confidence in nominal assets.26 27

29. Reserve-money growth slowed significantly in 1995 to around 20 percent, and was maintained at slightly above that rate during most of 1996 (Table 17). In the fourth quarter of the year, however, it accelerated to nearly 30 percent, as a strengthening in the enforcement of reserve requirements was accommodated by an expansion in reserve money. Underlying reserve-money growth (i.e., reserve money growth adjusted for this operation), however, would on official estimates have been roughly the same as in 1995.28

30. The sources of reserve money growth in the last two years were similar to 1994, but contrasted with earlier years. PBC credit to financial institutions, historically the main component of reserve money growth, was relatively restrained but there were large increases in net foreign assets (NFA) of the PBC (Chart 1). As in 1994, roughly two-thirds of reserve money growth in 1995 and 1996 was on account of NFA.29 With regard to broad-money growth, while domestic credit continued to be the main contributor, there was an increase in the contribution of “other items, net” (OIN) in 1995 and of NFA in 1996. The sharp increase in reserve money during the last quarter of 1996 reversed the upward drift in the money multiplier (Chart 2).

CHART 1
CHART 1

CHINA FACTORS CONTRIBUTING TO GROWTH OF RESERVE MONEY, 1993–96

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.
CHART 2
CHART 2

CHINA FACTORS AFFECTING THE GROWTH OF BROAD MONEY, 1993–96 1/

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.1/ Data relate to the banking survey. However, contributions of NFA and NDA to broad money growth for 1993 relate to the monetary survey, since sufficient data for the banking survey were not available.

31. The banking system’s NDA expansion slowed appreciably from nearly 30 percent in 1994–95 to 23 percent in 1996.30 Underlying the developments in NDA were relatively restrained growth in domestic credit as well as a reduction in “other items, net” (OIN) of the banking system. Growth in credit under the credit plan, which accounted for 60 percent of the credit extended by banks in 1996, was around 20 percent each year during 1994–96. There were reports that more credit was reallocated toward larger SOEs in 1996. After expanding substantially in 1995, OIN fell back sharply in end–1996, contributing to the slowing in NDA growth.31

C. Operations of the People’s Bank of China

32. The restrained monetary stance has reflected firm PBC control over reserve money. The efforts to curb reserve money growth were made, as mentioned, against the background of large increases in NFA, which the PBC, in part, sterilized through restraint in its credit to banks, and, in 1995, by selling PBC bonds to financial institutions (an open-market-type operation). Gross PBC claims on financial institutions increased only modestly; they followed the standard seasonal pattern of declining during the first half of the year and then rising slightly in the second half mainly on account of lending for agricultural procurement.32 The stock of PBC net claims on financial institutions has been falling each year, in 1996, while rising in the fourth quarter, it remained below the level in 1995.33

33. The PBC’s operational autonomy has been increasing and it has begun to make use of a range of intermediate monetary objectives and instruments in addition to the credit plan. For its intermediate objectives, the PBC has started to monitor a range of monetary indicators—broad money, narrow money, currency, and reserve money—in addition to the credit plan. While direct credit controls remain the primary monetary policy instrument, other instruments such as central bank lending, reserve requirements, and changes in administered interest rates have continued to gain in importance. Direct controls have become increasingly difficult to apply, evidenced by credit targets often being exceeded by substantial margins and leakages from the credit plan.

34. A troubling development in the last few years has been the increase of OIN in the PBC’s balance sheet. After more than doubling in 1995, it increased by more than one half in 1996 to Y167 billion by year-end. In the 12 months to September 1996, the increase in OIN was equivalent to over two-thirds of the increase in gross PBC claims on deposit-money banks and to 14 percent of the increase in reserve money. The increase in 1995 may have reflected PBC credit to policy banks and credit by local branches of the PBC to local bank branches and administrations, in addition to statistical adjustments. The increase in 1996 reflected to some extent purchases of policy bank bonds by the PBC through the postal savings system.

D. Operations of the Banking System

35. Recent years have seen measures to increase the market orientation of commercial banks. These efforts have been complemented by the creation of three policy banks whose scope has, however, remained relatively small. In the period since 1994, the operations of commercial banks have been marked by increasing autonomy, including through reduction in the scope of the credit plan, more freedom from obligations to make policy loans, and a stronger legal framework. In 1996, the credit plan was applied to the state commercial banks and two of the nationwide banks (rather than to all four of them as in 1995) in addition to the policy banks. Since 1995 banks have also been granted somewhat greater freedom in making working capital loans and in appraising projects for fixed-investment loans. Banks not covered by the credit plan are subject to the asset-liability ratio system, a system of key (mainly prudential) financial ratios (see Box 4). Some separation of policy lending from commercial lending was accomplished through creation of the three policy banks. The legal foundation for commercial bank operations was strengthened through passage of, inter alia, the Commercial Bank Law in 1995.

The Asset-Liability Ratio System

Financial institutions not covered by the credit plan are subject to the asset-liability ratio system.1 The system, while intended to govern banks’ financial activities, serves at present as more of a supervisory instrument (with fixed mandatory ratios) than an instrument of monetary policy (which is adjusted flexibly). The core of the system is a set of key financial ratios or “control targets,” which are imposed in addition to the reserve requirement equal to 13 percent of deposits. The main ratios are:

  • A capital-adequacy ratio of 8 percent of banks’ risk-adjusted capital, accompanied by a core-capital ratio of 4 percent;

  • A loan-deposit ratio of 75 percent, which can, however, vary across banks depending on financial circumstances;

  • A liquidity ratio (liquid assets as a proportion of liquid liabilities) of 25 percent;

  • A medium-term loans to medium-term deposits ratio of not more than 120 percent;

  • An excess-reserves guideline specifying banks’ excess reserves to be at least 5–7 percent of their deposits;

  • A single-client ratio: loans to a single client, and combined loans to the ten largest clients, cannot exceed 10 percent and 50 percent of a bank’s capital, respectively;

  • An interbank borrowing and lending ratio: a bank can borrow and lend on the interbank market only up to 4 percent and 8 percent, respectively, of the value of its deposits;

  • Loan-quality ratios, which include specifications that a bank’s overdue loans and bad loans cannot exceed 8 percent and 2 percent, respectively of its total loans.

  • An external borrowing ratio, which cannot exceed 100 percent of a bank’s capital; and

  • An external use of funds ratio: a bank’s external lending, external capital and external remittances cannot exceed 30 percent of its foreign assets.

These ratios are imposed on a bank-wide basis by the PBC. In addition to the control targets, which are stipulations, the system includes a set of “monitoring targets,” specified separately for domestic and foreign banks. The system is still preliminary but early compliance is considered encouraging. Several aspects—such as the timing with which compliance is required and whether the system adequately regulates risk—are being assessed with a view to strengthening the system, as well as to gradually extend the system to cover a larger number of banks.

1 In 1996, financial institutions not covered by the credit plan accounted for nearly a third of the expansion in total credit, and for nearly a fifth of the outstanding stock of credit.

36. Concerns have been expressed, by the authorities and others, about the profitability of banks, especially the state commercial banks.34 These stem from the large stock of nonperforming loans (estimated to be at least 20 percent of total loans), low interest-rate spreads,35 a heavy tax burden,36 and difficulties transferring policy loans to policy banks. While commercial banks are being given somewhat greater autonomy, they continue to face pressures to undertake policy lending, especially from local governments, some of it to loss-making SOEs. The PBC has begun to pay increasing attention to improving bank soundness, including by instructing the state commercial banks in 1996 to reduce the share of nonperforming loans in their total portfolios, increase loan-loss provisions, and shore up core-capital ratios.

37. The three policy banks were established in 1994, with a view to assuming the responsibility for policy lending and allowing the state commercial banks more scope for commercial operations.37 Policy banks’ operations have expanded, but remain small in relation to the banking system. As of end–1996, policy banks accounted for only 11 percent of the banking system’s total stock of outstanding loans.38 The policy banks are financed mainly through bonds sold to the state commercial banks. The bonds pay a rate of interest comparable to that on government bonds, although policy loans carry a below-market rate. The difference is subsidized by the budget.39 The policy banks’ focus on policy lending may be influencing the quality of their loan portfolios, although as noted the scale of their operations is relatively small.

E. Interest Rates

38. The interest rate structure in China is complex, with more than SO administered rates. Lending rates differ for fixed asset and working capital loans, and vary by maturity. In addition, rates are different for industrial and commercial loans, agricultural loans, and household loans.40 While banks are not allowed to apply margins on fixed asset loans, a margin of 10 percent is allowed on working capital loans. (Rural credit cooperatives (RCCs) and urban credit cooperatives (UCCs) are allowed margins of 60 percent and 30 percent, respectively.)41 Banks are not allowed to apply margins to deposit rates (but RCCs and UCCs have some flexibility in this regard).

39. Bank interest rates have begun to be adjusted more frequently in recent years, but their effect is still felt mainly through household deposits than bank lending, much of which is administratively determined. Interest rates were raised twice in 1995 and then cut twice in 1996, with the adjustments following developments in inflation, and the emphasis in both years was on increasing the lending margin for banks.42 The cuts in 1996 included a reduction of 2¼ percentage points in one-year fixed-asset loans and 3½ percentage points in one-year deposits. In addition, there was a reduction of 1½ points in the rate on temporary PBC loans to banks, and of nearly 1 point and 1¼ points in the remuneration rates on required and excess reserves, respectively (Tables 25 and 26).

Table 22.

China: Balance Sheet of State Commercial Banks, 1993–96 1/

(In billions of yuan; end of period)

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Source: Data provided by the Chinese authorities.

The category “State commercial banks” comprises the four specialized banks: Agricultural Bank of China, Bank of China, Construction Bank of China, and Industrial and Commercial Bank of China.

In keeping with the authorities’ presentation, “other items, net” is shown on the liabilites rather than assets side and does not net out bonds and owners’ equity.

Table 23.

China: Balance Sheet of Rural Credit Cooperatives, 1993–96

(In billions of yuan, end of period)

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Source: Data provided by the Chinese authorities. Based on a new statistical methodology introduced in 1994.

In keeping with the authorities’ presentation, “other items, net” is shown as a negative entry on the liabilities side, rather than a positive entry on the assets side, and does not net out bonds and owners’ equity.

Table 24.

China: Balance Sheet of Urban Credit Cooperatives, 1993–96

(In billions of yuan, end of period)

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Source: Data provided by the Chinese authorities. Based on a new statistical methodology introduced in 1994.

In keeping with the authorities’ presentation, “other items, net” is shown as a negative entry on the liabilities side, rather than a positive entry on the assets side, and does not net out bonds and owners’ equity.

Table 25.

China: Interest Rates on Loans, 1992-96

(In percent per year)

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Source: Data provided by the Chinese authorities.

One-year maturity.

Table 26.

China: Interest Rates on Deposits, Central Bank Loans, and Bonds, 1992-96

(In percent per year)

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Source: Data provided by the Chinese authorities.

Latest month available.

Effective July 1, 1991.

The inflation adjustment for deposits of three-year maturity and longer, which was re-introduced in July 1993 and was 13.2 percent in December 1993, was abolished on deposits made after April 1, 1996.

One-year maturity; for two years’ maturity, 14.24 percent; for 3-5 years’ maturity, 1 percentage point higher than that of individual deposits of the same maturity.

One-year maturity; for two years’ maturity; for three years’ maturity, 10 percent.

F. Financial Sector Reforms

40. In contrast with past episodes of macroeconomic stabilization, the current cycle did not entail a slowdown in the pace of structural reform. Financial sector reforms in recent years have been broadly in line with the reform strategy envisaged in the Decision of the Third Plenum (see Box 5). Reforms have focused on strengthening the PBC’s control over monetary policy, developing indirect instruments of monetary control, and gradually strengthening and liberalizing the financial system. Direct control over bank credit, in the form of the credit plan, is still the main monetary policy instrument, however, and is likely to remain so until the necessary infrastructure for indirect instruments is in place.

The Framework for Financial Sector Reform: The Decision of the Third Plenum1

The framework for the current phase of financial-sector reforms was laid down in November 1993 in the Decision of the Third Plenary Session of the 14th Central Committee of the Communist Party of China (referred to as the Third Plenum). The Decision articulated a reform strategy consistent with the goal of establishing by the end of the century a socialist market economy, envisaged as one in which market forces would play a primary role in resource allocation within the context of macroeconomic policies formulated by the central government The reform strategy entailed an accelerated pace of structural reforms in key areas including the SOE sector, the legal framework, the fiscal system, the exchange system, and, importantly, the financial sector.

Financial-sector reforms were envisaged to include strengthening the role of the central bank, further developing indirect instruments of monetary control, commercializing the financial system, and broadening and deepening financial markets. Key changes that were envisaged included:

  • Giving the PBC a mandate, under the guidance of the State Council, to implement monetary policy independently of other government agencies, and disallowing PBC financing of fiscal deficits; as well as assigning to PBC headquarters clear authority over its local branches.

  • Monetary policy implementation with decreasing recourse to direct credit control and based increasingly on indirect instruments such as reserve requirements, central bank lending rates, open market operations, and adjustments of banks’ deposit and loan rates.

  • Transforming the specialized banks into commercial banks, starting by establishing policy banks to take over policy lending; establishing new commercial banks; regulating commercial banks through asset-liability management and separating their activities from nonbank financial institutions; and

  • Strengthening the framework for interbank markets and rediscounting, and expanding the markets for bonds and stocks.

While key problems remain to be addressed in the financial sector, reforms since 1993 have progressed in the direction envisaged by the Third Plenum.

1This box is based on Hassanali Mehran and others, “Monetary and Exchange System Reforms in China: An Experiment in Gradualism” (IMF Occasional Paper Number 141, September 1996). For further discussion of the Third Plenum see also Wanda Tseng and others, “Economic Reform in China: A New Phase” (IMF Occasional Paper Number 114, November 1994).

41. The role of the PBC in conducting monetary policy has been strengthened through passage and implementation of the PBC Law (1995), which included key changes envisaged by the Third Plenum. The law granted the PBC autonomy from all other branches of government, making it liable only to the State Council, and in particular ended PBC financing of fiscal deficit.43 44 An important role in monetary policy formulation is intended to be played by a “monetary policy committee” reporting directly to the State Council (and including PBC representation), while policy implementation would be the sole responsibility of the PBC. The committee, eventually established in April 1997 as the “currency policy committee,” is now envisaged to play more of a consultative role in policy formulation, although details regarding its intended functioning and membership are not yet available. Finally, the law gave PBC headquarters explicit authority over local PBC branches, helping to regularize operations. It also vested the PBC with authority for supervision of financial intermediaries.

42. While the credit plan remains the main instrument of monetary policy, its scope has been narrowed and indirect instruments gradually developed on a small scale. The coverage of the credit plan, which in the past encompassed virtually the whole financial sector, has been reduced since the late 1980s.45 There are also indications that banks are being given increasing autonomy under the credit plan with regard to working-capital loans. Open-market operations have been undertaken since April 1996, although their scale remains limited in part because of the small stock of short-term Treasury bills outstanding. The PBC has also expanded on a limited scale the use of its rediscount facility.46 Bank lending and deposit interest rates have been adjusted more frequently, as noted, but there has been little increase in their flexibility. Notwithstanding the stricter enforcement of reserve requirements in 1996, there have been no recent adjustments in the required reserve ratio and in excess reserve guideline, which remain at 13 percent and 5–7 percent of deposits, respectively.47

43. The monetary framework is being strengthened by increasing the market orientation of commercial banks, through setting up of more banks and allowing selected foreign banks greater access to banking business; regularizing the operations of commercial banks by improving banking supervision; and by implementing key measures envisaged by the Third Plenum. Over the past two years, the authorities have encouraged the establishment of new financial institutions, including new banks in 100 cities and several large (nonbank) companies in the insurance sector. Several UCCs have been converted into banks, as envisaged in the Third Plenum, and the process has been extended to RCCs. In 1996, permission was granted to eight branches of foreign banks to engage in renminbi business on a limited scale, which the banks initiated in April 1997.48 Measures to strengthen banking supervision have included greater resources at the PBC for off-site supervision and a stipulation for every commercial bank to establish an internal audit department.49 As envisaged in the Plenum, and stipulated by the Commercial Bank Law, state banks have largely completed their disengagement from nonbank subsidiaries, effectively separating banking from nonbanking business and simultaneously narrowing an important channel for financial irregularities (including leakages from the credit plan).50 Efforts are being made to make the financial relationship between banks and large SOEs more transparent, including in the context of the “principal bank system” being established as part of the ongoing SOE reforms. Under the principal bank system, selected large SOEs are to conduct most of their financial dealings through a single bank. The bank, in addition to observing vigilance over the financial health of counterpart SOEs, is also given some influence over the operations of the SOEs.

44. Measures have been taken to expand and deepen financial markets, although most markets remain small in scope. An important measure with regard to money markets was the unification of the interbank market in January 1996. The unification contributed to a modest reduction in banks’ excess reserves—held, in part, due to inefficiencies in liquidity management, to which the fragmentation of money markets had in the past contributed. Liquidity in the market has remained low, however, as banks, unfamiliar with the new system, have tended to prefer intrabank transactions. The ceiling on the interbank rate (called the China Interbank Offer Rate, or CHTBOR) was lifted in June, and the rate in principle became market determined. The other main money market—for repurchases of government securities—is very small and fragmented, in part because of the small stock of marketable short-term government paper.

45. The stock market boomed during much of 1996, but remains small in relation to the economy.51 The boom in the stock market was reflected in a sharp rise in the prices of A–shares—by 100 percent in Shanghai and 250 percent in Shenzhen—through mid-December. Concerned that the boom was in part fueled by illegal trading practices, the authorities on December 13 announced a tightening of restrictions on irregular trading and imposed a 10 percent allowable band on daily share-price fluctuations. Share prices fell during the next few weeks, but recovered strongly in early 1997.52 The macroeconomic impact of stock market developments has been limited due to the small size of the market.

III. Fiscal Developments and Policy

A. Introduction

46. The fiscal system in China has undergone fundamental changes since the initiation of economic reforms, gradually assuming the characteristics of a modern public finance system. Steps have included the separation of state enterprises from the budget, the strengthening of the tax system, and the assignment of tax responsibilities to different levels of government. In addition, the negotiated corporate income tax payments that were introduced in the 1980s were replaced in 1994 by transparent tax rates and well-defined tax bases, and a rationalized system of indirect taxes has been introduced. Problems remain including weakness in the ratio of budgetary revenues to GDP and the proliferation of extrabudgetary funds. Moreover, notwithstanding the clarification of revenue assignments between different levels of government, a formal system of expenditure assignments and government grants has not yet been established.

B. Fiscal Developments During the 1980s

The tax system and budgetary revenues

47. Budgetary revenue developments during the 1980s reflected both the scaling back of the state budget’s role in resource allocation and structural weaknesses in the tax system. The decline in budgetary revenues during the years immediately after 1978 (Table 27) can in large measure be ascribed to the separation of the financial accounts of SOEs from budgetary transactions. Alongside the separation of budgetary revenues and SOE profits, budgetary expenditures for SOE investment were also gradually reduced, contributing to a decline in budgetary expenditures, from 34 percent of GDP in the early 1980s to around 21 percent by the end of the 1980s.

Table 27.

China: Budgetary Developments, 1980-96

(Percent of GDP, GFS basis)

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Source: Chinese authorities.

48. Following initial experimentation, fiscal reforms in 1984–85 replaced SOE profit remittances to the budget with taxation based on enterprises’ profitability. Whereas profit remittances of up to 15 percent of GDP had not been unusual, this source fell to less than 1 percent of GDP by the late 1980s. The new system was supplemented by the contract responsibility system to strengthen the financial accountability and autonomy of enterprises. This involved tax contracts with enterprises, typically of three years duration.53 The contracts, which applied mainly to medium and large SOEs, sought to balance the need for revenue with increased enterprise responsibility and autonomy, and were intended to provide enterprises with a strong performance incentive since “excess” profits could be retained.54 As a result of these reforms, the structure of revenues changed dramatically in the first half of the 1980s, as reflected in a jump in the share of taxes and a corresponding decline in the share of nontax revenue.

49. The tax system that emerged after the reforms that were introduced in 1984–85 relied heavily on consumption taxes (mainly excises and the turnover taxes on services). Of some importance also were income and profit taxes (mainly on SOE profits, since other types of enterprises enjoyed generous tax concessions), custom duties, and other taxes, mainly levies on enterprise profits. The system was characterized by numerous different taxes and large differences in effective tax rates across different types of enterprises, transactions and consumption items (the product tax, for example, was levied with rates ranging from 1½ percent to 69 percent).

Tax administration

50. A particular feature of the tax system that emerged during the 1980s was the role local governments played in tax collection and the absence of a nationwide tax administration system. Local tax bureaus had substantial powers to grant exemptions and other tax concessions within their area of competence, and the central government relied heavily on tax remittances from the local level.55

Intergovernmental fiscal relations

51. When looked at in a historical perspective, the system of intergovernmental fiscal relations in China has traditionally been highly centralized, with central government allocating most resources.56 However, during the 1980s, and in parallel with the increased autonomy granted to enterprises, larger powers were devolved to subnational governments. Apart from inherently central government functions (e.g., defense, foreign, and monetary affairs), the emerging new system led to a substantial overlap of administrative functions between different levels of government.

52. Local governments during the 1980s were assigned substantial taxing powers with taxes shared upward with the next level of government. While a system of tax sharing arrangements and tax assignment was formally in place, the sharing of tax revenues was largely negotiated between the center and regions. The system was formalized with the introduction of a contract-based tax-sharing system from the local to the central level, much akin to the system for enterprises. The objective was to increase fiscal flexibility and improve incentives for local tax collections; tax sharing arrangements were closely intertwined with the system of transfers from the central to the local level. When combined with the growing use of extrabudgetary funds (see below), the intergovernmental fiscal regime provided subnational governments with considerable room to address particular local problems and promote local economic growth. It, however, had an adverse effect on the ability of the center to raise revenues and conduct fiscal policy.

Expenditures and extrabudgetary funds

53. The level and composition of budgetary expenditures changed significantly with the gradual separation of SOE financial accounts from the budget in the early 1980s. Two key aspects of this process warrant comment. First, despite a separation of enterprises from budgetary revenue accounts, a close fiscal inter-relationship continued between SOEs and the budget as reflected in: (a) large, but declining, budgetary subsidies to the SOE sector, (b) SOEs continuing to supply the bulk of government revenue; and (c) SOEs providing substantial social services which in market economies would tend to be the responsibility of the government.

54. Second, a key aspect of the Chinese fiscal system has been the proliferation of extrabudgetary funds. Extrabudgetary funds have been a standard feature of the fiscal systems of many centrally planned economies and were introduced in China in the early 1950s to provide a flexible source of funds outside of budgetary appropriations.57 The decline in budgetary expenditures from 34 percent of GDP in 1980 to 21 percent in 1990, and the resulting tight control of the budgetary deficit,58 was associated with a significant increase in extrabudgetary operations. Thus, total extrabudgetary revenues increased from a little over half of budgetary revenues in 1980 to close to 110 percent by 1992 (based on Chinese classification principles).

55. A large share, however, of what were classified as extrabudgetary funds in China during the 1980s, comprises enterprises’ retained earnings and depreciation “funds” (according to some estimates these constituted as much as 80 percent of total extrabudgetary revenues) which do not represent fiscal funds. Lack of data, however, does not allow a precise analysis of developments in what may be considered as extrabudgetary fiscal funds, but the evidence suggests that the decline in budgetary revenues during the 1980s may not have been offset by the growth of (fiscal) extrabudgetary funds. With regard to the separation of enterprise accounts from the budget, the establishment of some of the extrabudgetary funds—with expenditures largely under government control—represented an intermediate step between the old system’s inclusion of SOEs’ accounts in the budget and their gradual separation from the budget.

C. The Public Finance Reform of 1994

56. By the early 1990s, the revenue system had become very complicated and was exhibiting very low buoyancy. The system was characterized by large differences in the effective tax burden on different enterprises and transactions, partly as the outcome of ad hoc negotiated tax contracts. In addition, there was a low degree of central government control over budgetary and extrabudgetary funds, with a potentially adverse impact on fiscal policy. The 1994 reform sought to address many of these problems. It included comprehensive measures, ranging from reform of the tax system and tax administration, restructuring of inter-governmental fiscal relations, and a new budget law.59 In addition, the Central Bank Law of 1995 included new rules for the financing of the budget. Even though the reform had a broad scope, however, it left some key problems unresolved: many tax concessions remained in place; a new transfer system from the central to local governments was not developed; and the problem of large off-budget operations was not adequately addressed.

57. With regard to reform of taxation and tax administration in 1994, significant measures were implemented to introduce a modem and “parametric” tax system with transparent and stable rates and well-defined tax bases. Key objectives of the 1994 tax reform were to “level the playing field” for different (domestic) enterprises and ownership structures, and to increase the buoyancy of the tax system. The base of the VAT was expanded to include a number of consumption items, with a standard rate of 17 percent; exports, however, were initially zero-rated at the standard rate (see below for later changes). Excises were simplified and streamlined with substantially fewer items and rates. Enterprise income taxes were harmonized, and the taxation of different types of domestic enterprises was unified at a standard rate of 33 percent (this standard rate also applies to FFEs). To improve transparency, all exemptions and other tax reliefs were intended to be specified in law. The personal income tax was modernized and unified for residents and foreigners, with statutory marginal rates varying between 5 percent and 45 percent.

58. The reform, however, left largely in place the generous system of tax concessions applying mainly to FFEs and joint ventures. The purpose of these tax concessions, which were introduced during the early and mid–1980s, was to attract foreign direct investment (FDI) and promote economic development.60 The main fiscal incentives introduced related to concessions on income and trade taxes. Based on a complicated set of eligibility criteria, FFEs in special economic zones (SEZs) were granted a liberal income tax regime, with income tax rates as low as 15 percent, and new enterprises were granted generous tax holiday provisions. FFEs were also granted exemptions on import VAT and duties for capital goods. Special rules applied to enterprises with a high share of exports and to technologically advanced enterprises.

59. Concerning tax administration, the 1994 reform split the administrative apparatus into a National Tax Service and a Local Tax Service, to collect taxes assigned to each level (see below) under the auspices of the State Administration of Taxation.

60. The system of intergovernmental fiscal relations was fundamentally changed in 1994 mainly through the replacement of the complex system of contract-based revenue sharing with one based on a clear delineation of tax assignment and tax-sharing arrangements between the central and local governments. A basic objective of the reform was to strengthen the centralization of fiscal revenues, with a goal of achieving a central government revenue share (before transfers) of 58 percent, in contrast to less than 40 percent prior to the reform.61 The new system operates with three categories of taxes: local taxes, collected largely by the local tax services (the business tax, personal income tax, and enterprise profit taxes on enterprises not owned by the central government); central taxes, collected by the national tax service, (including enterprise profit taxes on centrally owned enterprises, and excises); and shared taxes (mainly the VAT with a 75 percent share accruing to the central government) which are collected by the national tax service. To minimize disruptions, the reform was phased-in through a special system based on the calculation of a basic revenue amount guaranteed to each local government (based on actual revenue in 1993), with the new tax sharing arrangements applying only to increases in revenues above the basic amounts.

61. No changes were made to the prevailing expenditure assignments. According to the original intention, an important next step is to reform the complex system of (partly negotiated and largely gap-filling) transfers from the center to the regions and vice versa, with the introduction of modern equalization grants.

62. The new Budget Law, approved in 1994, introduced more up-to-date budget procedures, including more autonomy for local governments to prepare and approve their budgets. According to the law, local governments are not allowed to borrow to finance budget deficits.

D. Recent Fiscal Developments

Revenue developments

63. Revenue developments in the state budget have remained weak in recent years despite the objective of the 1994 tax reform to improve revenue buoyancy. The trend of the 1980s has continued, as reflected in a further decline in total state budget revenue to below 12 percent of GDP in 1995, from almost 20 percent in 1990. The continued decline can be attributed to inherent weaknesses in the tax system, resulting from the combined effects of generous tax concession, granted to the most dynamic sectors of the economy, and weak tax administration. Remaining problems in the sphere of intergovernmental relations may also have played a role in these developments.62 One recent positive development, however, has been the apparent stabilization of the revenue to GDP, at 11.4 percent in 1996 (Table 29). However, the tax-to-GDP ratio has continued to fall—albeit at a slower rate—with the stabilization in the revenue ratio reflecting primarily a pickup in nontax revenue. The level of budgetary revenue is low compared to the typical levels in other developing countries, although inclusion of off-budget operations alters the picture somewhat (see below).

Table 28.

China: State Budgetary Operations (GFS Format), 1993-97 1/

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Sources: Ministry of Finance; People’s Bank of China; State Statistical Bureau; and staff estimates.

These budgetary statistics represent a consolidation of the budgets 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, although there are plans gradually to incorporate them in the budget, starting with 13 central government funds. Seignorage revenues are not explicitly reflected in the budget Staff and World Bank estimates indicate that during the last ten years they averaged about 2 1/2 percent of GDP.

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

Change in gross credit to government less change in treasury deposits at the PBC.

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

Incorporates an estimate for policy lending of the banking system. For details, see the background paper on recent economic developments.

Table 29.

China: State Budget Revenue, 1993-97 1/

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Sources: Ministry of Finance; State Statistical Bureau; and staff estimates.

Compiled according to definitions contained in IMF, Manual on Government Finance Statistics, 1986.

Income tax and (before 1994) income adjustment tax on state enterprises.

64. The weakness in tax revenues has been reflected across-the-board, with taxes on income and profits declining from 7.4 percent of GDP in 1986 to 1.9 percent of GDP in 1996. Consumption taxes in the form of the VAT,63 excises, and turnover taxes on services, have been relatively more resilient, but have declined from 10.3 percent of GDP in 1986 to about 6.8 percent of GDP in 1996. The already considerable weight of the VAT in total tax revenue (almost SO percent, when VAT on imports is included) would have been even larger in 1996 in the absence of efforts to clear arrears on the export VAT refunds; the latter increased by more than 50 percent in 1996 compared to the previous year.

65. The decline in budget revenues has been accompanied by changes in the tax structure (Table 31), with the weight of consumption taxes substantially increasing, from 52 percent of total taxes in 1990 to almost 67 percent in 1996, and income taxes declining in relative importance (excluding personal income taxes). The weak performance of taxes on SOEs, which still account for about 60 percent of income and profit taxation (excluding the personal income tax), can mainly be attributed to their weakening profitability. Important factors which have adversely affected tax receipts from SOEs have included changed depreciation provisions, including accelerated depreciation under accounting reforms implemented in 1996; increased interest costs following the return of real interest rates to positive levels in recent years; reforms in social security that have increased payroll contributions of enterprises; and increased raw material costs due to declining price subsidies and/or administered price increases.

Table 30.

China: State Budget Expenditure and Net Lending, Functional Classification, 1993-97 1/

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Source: Ministry of Finance, and staff estimates. Data prepared according to GFS principles

Compiled according to the definition contained in IMF, Manual on Government Finance Statistics, 1986.

Table 31.

Changes in the Tax Structure, 1986–96

(Shares in percent of total tax revenues)

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

Data on the yield of the personal income tax are not available prior to 1995; the yield is included under “other taxes.”

Excludes the yield from VAT on imports.

66. Another key aspect of the tax system is the continued imbalance in the growth of central versus local tax revenues. In 1996, local revenues (i.e., revenues before grants) increased much faster than central revenues (26.2 percent versus 12.6 percent) (Table 34) resulting in a further decline in the central government revenue ratio to below SO percent. The impressive local revenue performance is explained by buoyant local revenue sources, such as the personal income tax and “business” (turnover) taxes on services, and a particularly forceful effort in collecting local taxes to meet expenditure needs. In addition, central government revenue was adversely affected by the relative slowdown of the growth in the bases of the VAT and excises, as well as the efforts to clear VAT refund arrears.

Table 32:

China: Subsidies, 1993-96

(In billions of yuan)

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Source: Ministry of Finance.

Includes subsidies for some means of production.

Table 33.

China: Government Bond Issues, Interest, and Repayment, 1993-97 1/

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Source: Ministry of Finance.

Owing to data deficiencies, it is not possible to establish full consistency between the data provided on bond financing and the data on budgetary financing.

Table 34.

China: State Budget, Central and Local Components, 1993-96 1/

(In billions of yuan)

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Source: Ministry of Finance.

Revenue and expenditure data compiled according to national definition.

67. Apart from these “autonomous” revenue developments in 1996, very modest policy changes have been implemented recently in the area of intergovernmental fiscal relations. A modest new grant to local governments of Y 2 billion (less than 1 percent of total transfers from the central to local governments) has been introduced.

68. A number of tax policy changes were made in 1996, the most important being the decision to repeal the exemption of import duty on capital goods imported by FFEs after the expiration of grandfathering provisions. The effective date for the repeal was initially set at April 1 1996, but full implementation has been delayed to 1998. In addition, as of January 1, the VAT rebate rate on exports was reduced from 14 percent to 9 percent (following the reduction from the standard rate of 17 percent as of July 1, 1995 to 9 percent). Some tax reliefs which were granted to domestic enterprises as a transitional means of alleviating the costs of the 1994 tax reform have expired. Many tax concessions extended to FFEs have, however, been kept in place.

Expenditure developments

69. State budget policies have continued to be guided by the Ninth Five-Year Plan and the target of balancing the state budget by 2000.64 Against this background, expenditure development in 1996 (Table 30) followed a similar pattern in recent years, with overall expenditures firmly controlled. Despite the objective to increase budgetary measures to support the structural reform effort, there were only marginal changes in the structure of state budget expenditures compared with the previous year. Current expenditures in 1996 increased to 10.8 percent of GDP and there was a small reduction in expenditures on capital projects as a share of GDP.65

70. Budgetary subsidies (including those provided to SOEs, in the form of price subsidies and subsidies to cover losses) declined to a shade above 1 percent of GDP in 1996. It should be noted, however, that budgetary subsidies constitute only a part of the direct fiscal support provided to enterprises, much of which takes the form of “tax expenditures”66 including to FFEs, and lending from the banking system. Precise estimates are not available on the magnitude of these means of support.

The state budget deficit

71. The deficit on the state budget narrowed marginally in 1996 compared to both the budget and the previous year’s outcome (Table 28). The budget deficit, on a preliminary basis, was 1.5 percent of GDP (on a GFS basis)67 in 1996 compared with 1.7 percent in the previous year. The budgetary deficit has thus remained within the fairly narrow range of 1½–2½ percent of GDP in most years since 1980. As in previous years, revenues were higher than envisaged in the budget, reflecting conservative budgeting procedures.

Financing of the state budget deficit

72. Budgetary financing has traditionally comprised Treasury bills, domestic bank financing and external borrowing. However, under the Central Bank Law of 1995, the central government, except in exceptional circumstances, is not to borrow from the PBC or the banking system (apart from the necessary short-term borrowing associated with day-to-day operations). Despite the decline in the state budget deficit as a share of GDP, gross domestic bond issues have risen sharply in recent years (Table 33). In 1996, total gross issues of domestic bonds amounted to Y 196.7 billion, or about 3 percent of GDP, with net issues (after amortization) equal to about 1.7 percent of GDP. The outstanding stock of government bonds at the end of 1996 amounted to 6.6 percent of GDP, up from 5.7 percent at the end of the previous year.

73. Along with the increase in bond financing, the government has taken steps to develop the domestic bond market. While bond issues traditionally have taken the form mainly of mandatory placements (particularly prior to 1994), a new competitive auction system was launched in 1996. This is to be followed in 1997 by a bidding system in the secondary market for Treasury bills as part of the gradual shift to open-market operations. At the same time, the traditional zero-coupon bonds have been supplemented with bonds carrying an annual interest (following a “pilot” issue in 1993), and maturities have been expanded up to 10 years (in contrast to the previous standard maturities of 3–5 years). To increase efficiency and reduce borrowing costs, new issues have been aimed mainly at wholesale investors (i.e., banks, insurance companies, and brokerages).

Extrabudgetary funds

74. Extrabudgetary funds continue to play a significant role in Chinese public finances. According to official estimates, the growth of the funds reached about 30 percent annually in recent years, above the growth of recorded budgetary operations. The off-budget funds and operations comprise broadly two different types of funds: five social funds68 and numerous off-budget funds and operations (sometimes referred to as “other extrabudgetary funds”), particularly at the local level (according to some estimates there are in excess of 900 funds and special fees). The extrabudgetary funds are financed through a variety of taxes, surcharges, and fees, and are sometimes earmarked for specific expenditure purposes, including notably infrastructure and other investments.69

75. Revenues and expenditures of the five social funds in 1995 have been estimated at about 1.7 percent and 1.5 percent, respectively, yielding a modest surplus of around 0.2 percent of GDP.70 On the basis of very preliminary data, it is estimated that the revenue of these funds was 2 percent of GDP in 1996 (no estimates of the surplus in 1996 is available at present). As noted above, these funds were previously regarded as enterprise costs, and consequently are not—in the Chinese classification—included as part of the government sector. This may explain why the data pertaining to these funds are relatively fragmented and less complete than state budget data. This situation may, however, change as a result of the comprehensive social security reforms under preparation by the Chinese authorities which involve the establishment of nationwide pension funds by the year 2000 as well as modern and comprehensive unemployment funds, financed in part by employee and employer payroll contributions. According to these plans, the intention is to require employees pay a larger share than under the present system.71

76. The pension fund system, which at present has a regional and enterprise specific character, and is restricted mainly to urban areas and the SOE sector, will in the future combine the basic insurance provided by the state with supplementary insurance by enterprises, and individual pension accounts. Experiments have been launched in selected cities and regions to identify the best design of the future social security system and its financing. The experiments also include a new health care program in a number of selected cities nationwide, programs under which employees’ medical costs are shared by the state, work units, and individuals, and the establishment of unified insurance management services.

77. In terms of the sheer size of their revenues and expenditures, other extrabudgetary funds are considerably more important than the social funds. However, owing to serious data deficiencies, it is difficult to assess the size of these funds and the purposes for which they have been established. The latest official data relate to 1994 (Table 35), and imply overall revenues of these funds of about 4 percent of GDP, and expenditures of 3.7 percent of GDP. The considerable uncertainty about the scope and nature of these off budget operations has for some time been a source of concern for the authorities. Consequently, the authorities created an interministerial working group in 1996, the Committee for Checking Extrabudgetary Funds, which is investigating these funds and the legality of those proliferating at the local level. A very provisional estimate by the working group is that the overall revenues of the funds in 1995 were between Y 240 billion (4½ percent of GDP) and Y 380 billion (6½ percent of GDP). The upper estimate would represent an increase of more than 2 percentage points of GDP in the estimated size of the other extrabudgetary funds, and thus of the magnitude of government operations, underscoring the considerable uncertainty associated with the size of government operations. It should be noted, however, that a number of extrabudgetary funds, including some of the 13 funds moved to the budget in 1997 (see below), relate to public utilities. In many countries, these are the responsibility of public or semipublic enterprises outside the budget (also, according to the principles of GFS, such nonfinancial public enterprises would be classified outside the general government).72

Table 35.

China: Other Extrabudgetary Funds, 1988-94 1/

(In billions of yuan)

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Source: Ministry of Finance.

Not including social funds. In addition, extrabudgetary funds were redefined in 1993 to exclude retained earnings and depreciation funds of SOEs.

Contributions to funds for energy, industry, transportation, and construction projects.

78. The authorities’ concerns regarding off-budget operations, originally intended as flexible means of implementing government policies, are based on the questionable legality of some of the funds and their adverse implications for central control over budgetary policies. The questionable legality refers to cases where localities have converted budgetary funds into extrabudgetary funds by unlawful means and where fees have been levied without authorization. Consequently, the central authorities have taken measures to better control funds and to increase the transparency of fiscal operations. In the context of the 1997 budget, 13 large central government funds with global revenues in excess of Y 100 billion (1½ percent of GDP) have been moved to the budget to improve the control of their operations.73 Also, in the second half of 1996, the central authorities issued guidelines to local authorities which prescribe strict measures to curb the growth of the funds.74 Over the medium term, the authorities expect that a significant share of existing off-budget operations will be terminated or incorporated into the budget.

79. To the extent that the new and still provisional information represents a reasonably precise picture of the scope of off-budget funds, the overall revenue ratio of the general government in China—including social and other extrabudgetary funds—may be in the range of 17–20 percent of GDP, or significantly above previous estimates. A final assessment will nevertheless have to await progress in clarifying the nature of these extrabudgetary funds and the identification of any additional funds.

A broader measure of the fiscal deficit

80. The existence of substantial off-budget operations combined with quasi-fiscal activities undertaken through the banking system (in the form of directed lending) make the state budget a misleading indicator of the fiscal policy stance. A more satisfactory measure would take into account the fiscal balances of the following four types of operations and entities:

  • The state budget;

  • The five social funds;

  • Other fiscal extrabudgetary funds; and

  • Policy lending of the banking system.

The problems relating to the first three of these have been discussed above. Even larger conceptual and statistical problems relate to the measurement of policy lending from the banking system, mainly for specific infrastructure investment purposes and loss-making SOEs. The fiscal nature of these credits—which are gradually being scaled back as the banking system becomes more commercially oriented—follows mainly from the fact that they are directed by the state, the key instrument being the credit plan, and some are subsidized at below-market interest rates. To some extent, the credit provided as policy lending is not repaid, although information on the default ratios is not available. Operations of this nature should ideally be included as budgetary operations, for example, as budgetary lending, and failure to include them in the fiscal accounts distorts the measure of the fiscal deficit.

81. In the absence of detailed information on policy-directed lending, there is no single and correct way of treating such lending in the fiscal accounts.75 Staff estimates of policy-directed lending, which are provided in Table 36, are calculated as between 40 percent and 60 percent of the overall credit plan throughout the period shown.76 Given the uncertainties, these estimates, however, should be interpreted as illustrations of rough orders of magnitude.

Table 36.

China: Estimates of a broad measure of the fiscal deficit, 1990–96

(In percent of GDP)

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Sources: Ministry of Finance; and staff estimates.

The coverage of the data was substantially altered in 1993; see Table 35.

Policy lending is assumed to amount to 40–60 percent of lending under the credit plan. More specifically, policy lending is assumed to comprise all loans under the credit plan for purposes of agricultural procurement and fixed investment. These categories usually account for about half of the credit plan; the range of 40–60 percent is applied in order to take into account the uncertainty involved in measuring policy lending. No information on policy lending is available for 1990–92.

The 1997 budget

82. A key objective of the Ninth Five-Year Plan is to eliminate the state budget deficit by the year 2000. Since only relatively modest revenue measures have been taken since the 1994 tax reform, expenditure restraint is bearing the brunt of the required fiscal adjustment.

83. The 1997 budget, which was approved by the National People’s Congress in March 1997, continues the financial policies of recent years with tight control of expenditures. Because of expenditure needs in the areas of agriculture, education and technology, and poverty alleviation, the deficit in 1997 is budgeted at 1½ percent of GDP, or the same as the actual outcome in 1996 (GFS basis).77 Interest expenditures are projected to continue to expand owing to the increase in bond financing in recent years (see above), whereas capital expenditures and budgetary subsidies are projected to decline relative to GDP.

84. Concerning revenues, a marginal decline to 11.2 percent of GDP is implied by the budget. This reflects a decline in nontax revenues back to the pre-1996 level, while tax revenues are expected to remain at about the same share of GDP as in 1996. Very modest changes have been made in tax policy. The most important change was the reduction as of January 1, 1997 in the enterprise income tax applying to state-owned financial institutions from 55 percent to 33 percent (the rate applied to domestic financial institutions), with an increase in the “business tax” (a turnover tax) on financial institutions from 5 percent to 8 percent. The policies of phasing out transitional tax concessions introduced with the 1994 reform was continued. A number of tax policy measures are being contemplated for possible introduction later in the year, including gifts and inheritance taxes to address distributional problems, and an adjustment in the calculation of the land use and urban maintenance tax.

IV. External Sector Developments

A. Introduction

85. External sector developments in China in the past four years have differed in several important aspects from earlier phases of the reform period. During 1982–92, China’s trade and current account positions were, on average, broadly in balance, capital flows were moderate, and the trend in reserves (in relation to imports) was essentially flat (Chart 3).78 Since 1993, developments in the external position have been dominated by large and sustained inflows of foreign direct investment (FDI) averaging some 5 percent of GDP annually. The counterpart to these capital inflows has been a rapid buildup of official reserves, which rose by more than $80 billion to the equivalent of nine months of imports of goods and nonfactor services at end–1996 (Table 37). The current account position79 has been little affected by the surge in FDI and has remained, on average, in broad balance, with a large trade surplus generated by domestic sectors more than offsetting the sharp rise in imports of capital goods and increasing profit remittances by FFEs (Chart 4).80

Table 37.

China: Indicators of External Sector Developments, 1992-96

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

Minus sign indicates increase.

Gross reserves of the People’s Bank of China, including gold, SDRs, reserve position in the Fund, and foreign exchange holdings.

Based on customs data.

Staff estimates of volumes are based on partner country prices.

December averages; through 1993 weighted average of official exchange rate and swap center rate.

Increase indicates appreciation.

CHART 3
CHART 3

CHINA BALANCE OF PAYMENTS DEVELOPMENTS, 1982–96

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: Data provided by the Chinese authorities; and Fund staff estimates.1/ Prior to 1995, reinvested earnings of foreign-funded enterprises are not adquately captured in the current account.2/ Excludes errors annd omissions.3/ End-period; in September 1992, the definition of official reserves was changed to include only foreign assets of the People’s Bank of China. Previously, foreign assets of the Bank of China were also included.
CHART 4
CHART 4

CHINA EXPORTS AND IMPORTS, 1993–96 1/

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: Data provided by the Chinese authorities; and Fund staff estimates.1/ Based on customs data.2/ Calculated as the difference between total exports(imports) and exports(imports) of FFEs.

86. The shift in China’s balance of payments in recent years has taken place against the background of significant changes in the exchange system, and, to a lesser extent, the trade system.81 A critical step was the unification of the exchange market in January 1994, and the concomitant lifting of many exchange restrictions on trade-related transactions. Subsequently, the remaining restrictions on other current payments and transfers were gradually removed and China accepted the obligations of Article VIII effective December 1, 1996. Some progress was also made in the area of trade reform with the trade package of April 1996, which included cuts in many import tariffs, a planned phasing out of import duty exemptions,82 as well as some measures to reduce nontariff restrictions. Since the unification of the exchange market, the exchange rate of the renminbi has been broadly stable via-à-vis the U.S. dollar and in nominal effective terms, but has appreciated in real effective terms due to higher inflation in China than in partner countries.

B. Merchandise Trade

Trade balance

87. After moving temporarily into deficit in 1993 at the height of the last investment boom, China’s trade balance began to register sizable surpluses in 1994. The trade surplus peaked at $18 billion (2½ percent of GDP) in 1995 and narrowed somewhat, to $14 billion, in 1996. Trade developments in early 1997 point to a continued strong position, with a surplus of $7 billion recorded in the first quarter.83 The strength of the trade balance in the past three years was partly due to rapid export growth, which averaged 36 percent in 1994 and the first half of 1995 (Table 38).84 Relatively modest import growth, however, contributed as well, particularly in 1996 when export growth slowed sharply.

Table 38.

China: Merchandise Trade, 1990-97

(In billions of U.S. dollars, customs basis)

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Source: Data provided by the Chinese authorities.

88. The strong trade balance has mainly reflected the behavior of domestic (non-FFE) sectors. With the surge in FDI inflows and rapidly increasing capital goods imports of newly established enterprises, imports of FFEs far outstripped their exports and the trade deficit of the FFE sector widened markedly, averaging more than 2 percent of GDP during 1993–96. These deficits were, however, more than offset by a significant rise in the trade surplus of domestic enterprises from an average of ¼ percent of GDP during 1985-92 to more than 3 percent of GDP during 1993–96.85 Relatively subdued imports and a temporary surge in exports played an important role in this turnaround (Table 39).

Table 39.

China: Exports and Imports by Customs Regime and Type of Enterprise, 1994-96

(Twelve-month percent change; customs basis)

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Source: Data provided by the Chinese authorities.

Exports

89. China’s export performance has varied considerably in the past four years.86 After growing at a relatively moderate pace in 1993, exports surged in 1994 and remained very strong through the first half of 1995. Export growth weakened sharply, however, in the second half of 1995 and turned negative in the first half of 1996, followed by a recovery in the latter part of the year, which gained momentum in early 1997. These fluctuations reflected mainly developments in the exports of domestic enterprises, which grew at an average annual rate of 35 percent (customs basis) in 1994 and the first half of 1995, and declined at an annual rate of nearly 10 percent in the second half of 1995 and 1996. Exports of FFEs expanded at a strong and relatively steady rate, averaging 35 percent (annual rate, customs basis) during 1994–96. As a result, their share in total exports rose from less than 30 percent in 1993 to 41 percent in 1996.

90. The reform of the exchange system and changes in the tax system regarding the treatment of exports under the VAT appear to have been important factors influencing export developments in recent years. As a result of the abolition of the retention quota system and the unification of the exchange rate at the prevailing swap market rate in January 1994, domestic firms benefitted from a more depreciated exchange rate.87 Moreover, the exchange reform entailed a considerable simplification of the exchange system. Also in 1994, with the broadening of the VAT, zero rating for exports was introduced for domestic firms and newly established FFEs.88 Both the reform of the exchange system and the change in the VAT contributed to the strong pickup in the exports of domestic enterprises in 1994.

91. In response to mounting evidence of fraudulent VAT rebate claims,89 the rebate rate for exports was reduced from 17 percent (the standard VAT rate) to 13 percent effective July 1, 1995. As this change was preannounced, exports were brought forward to the first half of 1995, with a resultant sharp slowing of export growth in the second half of the year. At the same time, the effects of the 1994 exchange reform were beginning to taper off. Exports continued to weaken in the first half of 1996 following a further reduction in the VAT rebate rate to 9 percent in January and increasing delays in rebate payments. While the VAT rebate rate was subsequently kept unchanged, rebate payments were accelerated, contributing to the recovery of exports in the latter part of the year.

92. A notable development in recent years has been the continued rapid expansion of processing trade,90 which has grown faster and more steadily than ordinary trade, accounting for more than half of total exports (customs basis) in 1996. As regards the commodity composition of Chinese exports, the share of manufacturing exports has risen further in recent years to 85 percent in 1996, compared with just half of total exports in 1985 (Table 40). While exports of textiles and clothing continue to play an important role, exports of machinery and equipment have grown particularly fast and now account for more than one fifth of China’s exports.

Table 40.

China: Exports by Commodity Group, 1985-96 1/

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Source: Data provided by the Chinese authorities.

Customs basis. From 1980 to 1991, exports were classified according to Commodity Classification for China Customs Statistics, which was based on SITC Rev.2. In 1992, a new classification science was introduced in accordance with the Harmonized System.

93. China’s share in world exports has risen significantly since the mid 1980s, although it declined slightly in 1996 due to the weak export performance of domestic enterprises (Chart 5). With a large part of Chinese exports shipped via Hong Kong, trends in their regional distribution are difficult to assess because customs statistics do not adequately reflect the final destination of exports. As a result of improvements in the geographical disaggregation of Chinese customs statistics,91 the share of recorded exports to Hong Kong in total exports dropped sharply in 1993 but remained relatively large, averaging nearly one-fourth in recent years (Table 41). Nevertheless, the available data suggest that the greater part of Chinese exports goes to industrial countries, with the European Union, Japan, and the United States accounting for more than half of the total in 1996.

CHART 5
CHART 5

CHINA SHARE OF WORLD EXPORT MARKETS, 1980–96 1/

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: International Financial Statistics; and WEO data base.1/ Total Chinese merchandise exports as percent of world non-oil imports.
Table 41.

China: Direction of Trade, 1985-96 1/

(In percent of total)

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Source: IMF, Direction of Trade Statistics.

There are breaks in the series in 1993 due to a change in classification of exports and imports shipped via Hong Kong.

Imports

94. After accelerating to nearly 30 percent in 1993, import growth moderated to 13 percent in 1994–95 and slowed further to 5 percent in 1996. This trend continued in the first quarter of 1997, with imports declining by 2 percent compared with the same period in the previous year. The sharp rise in imports in 1993 reflected both a surge in FDI-related imports and strong imports by domestic enterprises associated with booming investment demand. Subsequently, imports of FFEs moderated but, nevertheless, continued to grow on average by more than 20 percent during 1994–96.92 Imports of domestic sectors,93 however, slowed sharply, increasing at an average rate of less than one percent during the same period, notwithstanding a strong increase in imports of cereals in 1995 to supplement domestic supply.

95. The slow growth of domestic (non-FFE) imports in the past three years appears to be partly due to the moderation of investment activity during the recent stabilization. Nevertheless, real GDP growth has remained relatively robust at around 10 percent, implying a very low-income elasticity of non-FFE imports.94 The latter seems to be in large part the result of a trade regime that is still characterized by numerous nontariff restrictions, such as licencing requirements, quotas, and state trading for selected commodities, a relatively complex tariff structure and restricted access to trading rights.95 The April 1996 trade package, which focused mainly on tariff cuts and a planned phasing out of duty exemptions, changed the trade system only at the margin. Finally, while the effective depreciation implied by the exchange reform of 1994 may have contributed to the slowing of import growth in recent years, the overall impact of the reform is difficult to assess because the removal of restrictions on trade-related exchange transactions and the simplification of the system facilitated imports.

96. The commodity composition of Chinese imports has been broadly unchanged since the mid 1980s, with imports of manufactures accounting for the vast majority, some 85 percent, of total imports (Table 42). Due to slow growth of imports of machinery and some other manufactures categories, as well as a near doubling of food imports, the share of manufactures imports fell in 1995. Nevertheless, manufactures continue to account for more than 80 percent of total imports, and machinery alone for 40 percent. With more than half of exports based on processing trade, imports for export processing make up a substantial part of Chinese imports, amounting to 45 percent in 1996. Reflecting the role of processing trade and the large share of machinery imports, Chinese imports have been dominated by investment and intermediate goods, with consumer goods, including food imports, accounting for just over a quarter of total imports in recent years.

Table 42.

China: Imports by Commodity Group, 1985-96 1/

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Source: Data provided by the Chinese authorities.

Customs basis. From 1980 to 1991, imports were classified according to Commodity Classification for China Customs Statistics, which was based on SITC Rev.2. In 1992, a new classification scheme was introduced in accordance with the Harmonized System.

97. The geographical distribution of Chinese imports, like that of exports, is heavily concentrated in the Asia region, from which 60 percent of total imports originate. The share of imports from Hong Kong is relatively small—less than 6 percent in 1996—suggesting that the distortions in the regional breakdown of trade resulting from shipments through Hong Kong are smaller on the import side than on the export side. A large part of Chinese imports come from industrial countries, with the European Union, Japan, and the United States accounting for nearly half of total imports in recent years. While Japan remains China’s largest trading partner, imports from other Asian partners have expanded rapidly since the early 1990s. In 1996, one fifth of China’s imports originated in Korea and Taiwan Province of China.

C. Other Current Transactions

98. Developments in the past four years in the services and income balance are difficult to interpret due to changes in the coverage of important component series.96 Nevertheless, the broad picture that emerges indicates a shift from moderate surpluses prevailing throughout the 1980s and early 1990s to deficits of orders of magnitude similar to recent trade surpluses, implying a broadly balanced current account (Table 43). The main factor underlying this shift has been the sharp rise in profits of FFEs, of which a large part appear to have been reinvested. While the increase in payments of investment income in 1995 is exaggerated due to inadequate balance of payments statistics, which do not include FFE profits for earlier years, staff estimates suggest that the distortions resulting from this omission were relatively small before the recent surge in FDI, which started in 1993.97

Table 43.

China: Balance of Payments - Current Account, 1992-96

(In millions of U.S. dollars)

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Source: Data provided by the Chinese authorities.

99. As regards services transactions, receipts from travel-related services and processing trade (included in “other services, credits”) have emerged as major sources of foreign exchange earnings in recent years, accounting together for three-fourths of services receipts in 1996. With rapid increases in travel receipts outpacing payments, the surplus in the travel balance has risen steadily. Trade-related services, however, have registered widening deficits, and payments for business-related services (included in “other services, debits”) have risen steadily. Investment income flows excluding FDI-related profits have been broadly in balance, reflecting approximate balance in the underlying foreign asset and liability positions, while the transfer balance has continued to register small surpluses.

D. Capital Account and Unrecorded Transactions

100. As noted above, the most striking development in China’s external position has been the sharp increase in FDI inflows since 1993, which, on a cumulative basis, amounted to almost $140 billion in the past four years (Table 44).98 This surge occurred against the background of a general rise in FDI flows to developing countries, of which China absorbed nearly half, compared with 15–20 percent during 1982–91.99 The broadening and deepening of economic reforms since 1992 appears to have helped enhance China’s attractiveness for foreign investors. Most of the FDI in recent years has originated in Hong Kong, which accounted for almost two thirds of total FDI inflows in 1993 and still for over 50 percent in 1995 (Table 45). Other major investors have been Japan, Taiwan Province of China, and the United States, each accounting for nearly 10 percent of FDI inflows in 1995.100 Attracted by the incentives offered in the special economic zones (SEZs) and other open areas,101 most foreign investment has been concentrated in the eastern and southern coastal regions, notably Fuijan, Guandong, Jiangsu, Shandong, and Shanghai, which together absorbed some two thirds of FDI inflows during 1993–95.

Table 44.

China: Balance of Payments - Capital Account and Reserves, 1992-96

(In millions of US. dollars)

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Source: Data provided by the Chinese authorities.
Table 45.

China: Foreign Direct Investment Inflows, 1991–96

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Sources: China Statistical Yearbook; and data provided by the authorities.

101. Compared with FDI inflows, other capital flows have remained modest, due to continued controls on most capital account transactions.102 Reflecting international bond issues as well as modest inflows into the stock market,103 recent net inflows of portfolio capital have been somewhat larger than in the 1980s, averaging $2.5 billion annually during 1993–96, while net inflows of other medium- and long-term capital have declined, averaging just over $1.5 billion during the same period. In 1993–94, these inflows were largely offset by modest outflows of short-term capital, implying broad balance in the capital account excluding FDI. In 1995–96, net flows of short-term capital were negligible, with portfolio and other long-term capital adding some $4 billion annually to FDI inflows.

102. With the growing importance of international transactions, the existing systems for recording these transactions appear to have become increasingly inadequate and, as a result, errors and omissions in the balance of payments have risen significantly since the early 1990s. In 1990–92, such unrecorded transactions amounted to a net outflow of about $6 billion annually, rising to some $10 billion in 1993–94, and almost $18 billion in 1995. Preliminary balance of payments data for 1996 indicate another large net outflow on account of unrecorded transactions of close to $15 billion. These large errors and omissions greatly complicate the analysis of balance of payments developments. While they may reflect in part the unrecorded capital outflows associated with “round tripping” in the context of FDI flows, inadequate coverage of other capital and current account transactions is likely to have contributed as well.

E. International Reserves

103. With the current account on average broadly in balance, the large capital inflows in the past four years have led to a rapid accumulation of international reserves. While reserves were largely unchanged in 1993 as the current account temporarily shifted into deficit, the PBC’s foreign exchange assets began to rise sharply in 1994, increasing cumulatively by more than $80 billion during 1994–96. Gross official reserves rose from $23 billion at end–1993 to $108 billion at end–1996, and continued to grow in the first quarter of 1997 to nearly $115 billion at end–March (Table 46). As a result of the rapid accumulation of foreign exchange assets, the import cover of reserves almost tripled from 3½ months of imports of goods and nonfactor services at end–1993 to more than nine months at end–1996.

Table 46.

China: International Reserves, 1990-97

(In millions of U.S. dollars)

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Source: People’s Bank of China.

The authorities define gross official international reserves as the sum of the foreign exchange assets of the People’s Bank of China (State Reserves), gold (valued at SDR 35 per fine troy ounce), reserve position in the Fund, and SDR holdings. This new definition was introduced in August 1992.

F. External Debt

104. According to Chinese debt statistics, China’s external debt has risen steadily since the early 1980s, reaching $116 billion at end–1996 (Table 47). These data, which imply average annual increases of close to $8 billion over the past 15 years, are difficult to reconcile with balance of payments data on debt-creating flows, which would suggest much smaller increases.104 In any case, external debt has remained moderate in relation to the size of the economy. The debt-GDP ratio peaked at close to 20 percent in 1993 and has declined in the past three years to 14 percent at end–1996. Most of China’s debt has medium- and long-term maturity, with short-term debt accounting for 12 percent of total debt in 1996. Approximately one third is owed to official creditors and about one-fifth to foreign banks, while trade-related debt amounted to just over 10 percent of total debt in 1996. As of mid last year, over half of China’s external debt was denominated in U.S. dollars and just over one-fourth in Japanese yen. Debt-service payments in relation to export earnings have declined steadily in the past four years to less than 7 percent in 1996.

Table 47.

China: External Debt by Creditors and Type of Credit, 1990-96

(In billions of U.S. dollars; end of period)

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Sources: Data provided by the Chinese authorities; and OECD, Financing and External Debt of Developing Countries.

Based on GDP in U.S. dollars converted at the weighted average of the official and the swap market exchange rate prior to 1994.

G. Exchange Rate Developments

105. Since the unification of the exchange market in January 1994, the exchange rate of the renminbi has been broadly stable both vis-à-vis the U.S. dollar and in nominal effective terms (Chart 6).105 While the exchange rate unification at the prevailing swap market rate implied a 50 percent devaluation of the official exchange rate, the effective depreciation is estimated to have been less than 10 percent because by late 1993 a large part of foreign exchange transactions were already effectively carried out at the swap market rate. The exchange rate of the renminbi against the U.S. dollar appreciated subsequently by 3½ percent from mid–1994 to mid–1995 and has since fluctuated within a relatively narrow margin around Y 8.3 per U.S. dollar. The real effective exchange rate based on relative consumer prices, however, has appreciated by 25 percent from the beginning of 1994 to end–1996, reflecting higher inflation in China than in partner countries, particularly in 1994 and 1995.

CHART 6
CHART 6

CHINA EXCHANGE RATE DEVELOPMENTS, 1988–1997 1/

Citation: IMF Staff Country Reports 1997, 071; 10.5089/9781451807738.002.A001

Sources: Data provided by the Chinese authorities; and staff estimates.1/ Monthly average; downward movement indicates depreciation of the renminbi.2/ On January 1, 1994, the exchange rates were unified at Y 8.7 per U.S. dollar. Since then the rate has been determined in the interbank market.3/ These centers were established in late 1986.
1

The term “country” as used in this paper does not in all cases refer to a territorial entity that is a state as understood by international law and practice. The term also covers some territorial entities that are not states but for which statistical data are maintained and provided internationally on a separate and independent basis.

2

This observation is based on news reports and data from a 1995 industrial census showing a number of sectors with low capacity utilization rates (see the background paper on developments in the SOE sector). No consistent time series on capacity utilization is available.

3

Components of real aggregate demand are not published by the authorities. The assessment in the text is based on staff estimates.

4

Official estimates suffer from a number of shortcomings, including the discrepancy between the expenditure and income-based measures of GDP. Figures for consumption in Table 2 are staff estimates derived residually by subtracting the other components of aggregate demand from total output. This procedure implies that the statistical discrepancy between the income and expenditure based estimates of GDP is included in the estimate for consumption.

5

Net exports of goods and nonfactor services are derived from the balance of payments and converted to domestic currency using the dollar exchange rate.

6

The figures in Table 3 are for investment by the state-owned sector, which accounts for more than half of total fixed-asset investment.

7

State-owned units comprise, in addition to SOEs, government units.

8

Stock accumulation in earlier years reflected a higher share of unsold industrial inputs (rather than final goods) as the construction boom in 1992–93 started to slow.

9

Real growth rates in this section are derived using 1990 prices.

10

Personal income figures may be underestimated, as they do not include income from many private or informal sources; this would imply that personal saving rates are understated, and saving rates from profit and other income overstated.

11

The figures for services employment are somewhat overstated, as they include a large “other” category which consists of unidentified rural labor activity.

12

Registered unemployment figures include not only separated workers but also new entrants into the labor market as well as some migrants from rural areas.

13

The Ministry of Labor estimates that there are more than 27 million redundant or jobless workers in need of reemployment in urban areas, excluding rural migrants, with the majority of these redundant workers from SOEs.

14

Ministry of Labor estimates; this number may be overstated due to the difficulty of measuring nonagricultural activity in rural areas.

15

For more on the macroeconomic cycles and factors underlying the recent soft landing, see the background paper on macroeconomic cycles in China.

16

This index is also referred to as the consumer price index (CPI); the two terms are used interchangeably in what follows.

17

The incomplete pass-through of the procurement price increase was reflected in lower retail prices than procurement prices in some regions.

18

For a description of the structure of the banking system, see Box 3.

19

All growth rates are on a 12-month, end-of-period basis—unless otherwise noted.

20

In January 1994, the official and swap exchange rates were unified at the prevailing swap rate of Y 8.5 per dollar. Subsequently, the rate has appreciated very slightly to Y 8.3 per dollar. In nominal effective terms, the exchange rate appreciated by 2 percent between January 1994 and end–1996. In real effective terms, it appreciated by 25 percent, mainly reflecting higher inflation in China than in partner countries.

21

This was in fact the slowest rate of currency growth ever recorded in the People’s Republic of China.

22

The innovations have included a spread in the practice of enterprises directly depositing workers’ wages in banks.

23

Deposits as a share of GDP increased from around 85 percent in 1993–94 to 99 percent in 1996, with nearly all of the increase being on account of longer-term deposits. The increase was reflected in strong growth in the quasi-money component of broad money during the period. A slowing in quasi-money growth during 1996, however, may suggest that reintermediation is nearly completed.

24

The PBC announced an inflation adjustment premium or “subsidy” each month that offset the difference between inflation and nominal interest. The cost of the subsidy was in the first instance borne by banks, which were later compensated by the budget. Since the budgetary compensation took the form of lowering banks’ tax obligations, however, it does not appear explicitly in the budget.

25

The subsidy was retained for deposits made before April 1, 1996. That is, it will be paid on relevant deposits made before April 1, 1996 if upon maturity the cumulative interest on those deposits turns out to be less than cumulative inflation. This is a consideration until April 1999 (since the subsidy applies mainly to three-year deposits).

26

On an end-year basis, the decline in inflation was more marked in 1995 (when it fell by over 12 percentage points) than in 1996 (when it fell by 4 percentage points). It is plausible, therefore, that the downward revision to inflationary expectations largely happened in 1995, which was also when saving-deposit growth was strongest.

27

Two additional considerations are worthy of note. First, the huge increase in saving deposits (in 1993–96) took place against the background of roughly no change in the national saving rate as a share of GDP (just over 40 percent) and only a slight increase in nongovernment saving. There must, therefore, have been a large decline in savings held elsewhere in the economy. Second, the stock market—sometimes cited as a key alternative to banks as a vehicle for savings—boomed in 1996.

28

Until October 1996, the reserve deposits of rural credit cooperatives were held at a state bank—the Agricultural Bank of China (ABC)—rather than at the People’s Bank of China (PBC). In November, these deposits were transferred to the PBC, which extended credit to the ABC to make up for the resulting reduction in ABC’s liabilities. Reserve-adjusted monetary growth (i.e., the growth in reserve money excluding the above credit from the PBC) is estimated at 20.3 percent.

29

While NFA and net domestic assets (NDA) made roughly equal contributions to reported reserve-money growth in 1996, their contributions to underlying reserve money growth were consistent with the pattern in 1994–95. This pattern was also reflected during the first three quarters of 1996, when NFA contributed about two-thirds of reserve-money growth.

30

Due to the emergence of large “other items, net” (OIN)—some of which represents misclassified credit—in the monetary accounts in recent years, NDA (comprising domestic credit and OIN) rather than recorded domestic credit may provide a broader picture of overall credit developments.

31

Two points concerning developments in banks’ OIN are worth noting. First, the fall in OIN is indicated in the banking survey but not in the monetary survey (Table 16). The increase in OIN in the monetary survey, however, suggests a more modest decline in NDA growth—to 24 percent rather than 23 percent—and not a pickup. Second, the different patterns of OIN in the monetary and banking surveys reflect that the OIN of deposit money banks increased substantially, mainly on account of the state commercial banks, but were outweighed by a decline in OIN of “other banks” (included in the banking but not the monetary survey).

32

Of the large increase (Y 335 billion) in PBC claims in the fourth quarter, a little under half is believed to be related to the above-mentioned transfer of reserve deposits. The remaining increase, while still large, should be viewed against the concurrent large increase in deposits at the PBC.

33

Net claims as referred to here comprise gross PBC claims on deposit money banks and other financial institutions less required- and excess-reserve deposits at the PBC and deposits of other financial institutions at the PBC.

34

The background paper on banking sector development and policy issues includes a fuller discussion.

35

The margin between lending and deposit interest rates, although it has been widened during the last couple of years, remains very small. In 1995, the weighted average lending rate was officially estimated at 12 percent, and the deposit rate (excluding the inflation subsidy) at 9–10 percent; however, once the subsidy was taken into account virtually no margin remained. In 1996, lending and deposit rates were cut, on average by 2 percent and 2½ percent cumulatively, slightly improving the margin.

36

Until this year, income tax was levied on domestic financial institutions at a rate of 55 percent, compared with 33 percent on other enterprises. In January, the income tax rate for domestic financial institutions was reduced to 33 percent and the business tax rate raised from 5 percent to 8 percent.

37

The three policy banks are the Agricultural Development Bank of China, the State Development Bank, and the Import and Export Bank of China, and have broadly distinct areas of lending operations.

38

The largest policy bank, the Agricultural Development Bank of China, accounted for over 80 percent of policy bank lending.

39

The subsidy is not, however, explicitly indicated in the official presentation of the budget.

40

In the last few years, PBC has made efforts to simplify the rate structure, including by reducing the number of rates.

41

An intended unification of different institutions’ lending margins at 30 percent, along with the attendant widening in banks’ lending margins, did not take place in 1996.

42

In 1995, the adjustments mainly entailed higher lending rates; in 1996, they involved larger cuts in deposit than in lending rates.

43

Jurisdiction over seigniorage revenues is not clear, however. Seigniorage, measured here by the increase in currency in circulation (rather than by reserve- money expansion, since banks’ reserves are remunerated by the PBC), which is estimated at about 2½ percent of GDP annually during the past decade, is not explicitly indicated in the PBC or budgetary accounts.

44

Strictly, direct PBC financing of the deficit was terminated in all but exceptional circumstances (for example, following natural disasters). In practice, net credit from the PBC to the government has turned negative in recent years.

45

Credit extended under the credit plan was Y 800 billion in 1996 (equivalent to nearly 60 percent of the expansion in overall bank credit, as mentioned, and to 70 percent of the expansion in credit by deposit money banks (DMBs)). It comprised Y 576 billion in working capital loans, Y 205 billion in fixed-investment loans, and Y 19 billion in agricultural procurement loans. The share of working-capital loans was much higher than in most years. The credit plan for 1997 amounts to Y 850 billion, of which Y 430 billion is intended for working capital loans, Y 255 for fixed investment loans, and Y 165 for agricultural loans.

46

At end–1996, the trading volumes in open market and rediscount operations were each around Y 4 billion, equivalent to less than ½ percent of the PBC’s claims on financial institutions.

47

The cut in interest rates in August did, however, entail a deeper cut in the remuneration rate on excess reserves than on required reserves.

48

The initial scope of operations remains limited—for example, the banks are permitted to make RMB loans in an amount not exceeding 35 percent of their RMB liabilities—but may gradually be expanded after some experience has been gained.

49

Weaknesses in key financial data necessary for effective supervision may, however, have diminished the impact of some of these measures.

50

There have also been efforts to regularize the operations of nonbank financial institutions, if necessary by closing down institutions found to be engaging in irregular activities. A widely publicized recent case was the closure of the China Agricultural Development Trust and Investment Company (CADTIC) in January.

51

China’s two stock exchanges were established in Shanghai and Shenzhen in 1990 and 1991, respectively. Shares are of two main types—so-called A–shares reserved for Chinese residents, and B–shares reserved for foreigners. A–shares account for virtually the whole market, and trade at a large premium relative to B–shares. Total market capitalization in the two exchanges was around 18 percent of GDP as of end–1996.

52

More recently, share prices fell somewhat in April-May, following official approval of substantial new listings and an announcement of stronger restrictions on SOEs’ participation in the market, but remained well above their level last year.

53

In practice, even after contracts had been signed, the government retained some discretion to grant ad hoc relief and exemptions.

54

For more details on this system, see People’s Republic of China: Background Paper (SM/94/71, 3/21/94), pp. 48–53.

55

For more details, see People’s Republic of China: Background Papers (SM/94/71, 3/21/97), pp. 52–53.

56

The system of intergovernmental fiscal relations is described in more detail in the background paper.

57

See, for example, Wong, Heady, and Woo, “Fiscal Management and Economic Reform in the People’s Republic of China,’’ ADP, Oxford University Press, 1995, for an account of the extrabudgetary funds.

58

The deficit has been held at a modest 1½–2½ percent of GDP per year in most years since the inception of reforms, see Table 27.

59

The reform is described in detail in “Economic Reform in China, A New Phase,” IMF Occasional Paper 114, November 1994.

60

The system of investment incentives is described in People’s Republic of China: Background Paper (SM/95/44, Supplement 1, 3/9/95), Section IV.

61

The authorities had earlier indicated a target share for central government revenue (before transfers) of 60 percent.

62

People’s Republic of China: Selected Issues (SM/96/67, Supplement 1, 3/26/96), Section I, provides background on the revenue decline.

63

It is customary to classify the VAT as a consumption tax, although the limited deductibility of VAT on capital inputs in the Chinese system makes it different from a pure consumption tax.

64

The target is formulated in terms of the Chinese budget presentation and thus excludes interest payments.

65

No information on the economic breakdown of the budget is available, including on wage costs.

66

That is, subsidies provided in the form of tax concessions, which might have been granted as direct budgetary subsidies; tax expenditures are generally less transparent than explicit budgetary subsidies.

67

The main difference between the GFS and Chinese definition of the deficit is that the latter excludes interest costs on government debt from expenditures and, hence, from the deficit.

68

Pension funds, unemployment fund, medical fund, injury fund, and maternity fund.

69

The Asian Development Bank has recently launched a study to clarify the magnitude, financing, and purposes of the extrabudgetary funds.

70

Based on estimates of the pension funds and the unemployment fund. The three other funds are believed to be very small.

71

The contributions to the pension funds vary considerably across regions, but are estimated on average to constitute about 20 percent of wage costs for employers, and about 3 percent for employees. The aim is to increase employees’ contribution gradually to about 8 percent of wages. The unemployment fund is mainly employer-financed with contributions ranging from 0.6 percent to 1 percent of wage costs.

72

As an example, one of the 13 central funds is the “Three Gorges Project Construction Fund.”

73

The funds continue, however, to operate independently with separate treasury accounts. The associated revenues and expenditures are not yet consolidated with the budgetary revenues and expenditures presented in Tables 28–30.

74

State Council Notice No. 29 of July 11, 1996 on Tightening the Regulation of Extrabudgetary Funds.

75

A comprehensive discussion of the conceptual and statistical problems is provided in “Quasi-Fiscal Operations of Public Financial Institutions,” by G.A. Mackenzie and P. Stella, Occasional Paper 142, IMF, October 1996.

76

It is assumed that policy lending under the credit plan comprises credits for agricultural procurement and fixed assets loans, which roughly correspond to about half the credit plan. A range has been applied to take into account the uncertainties involved.

77

The budget projections for 1997 are based on the staff’s economic assumptions. The economic assumptions underlying the budget are not made explicit.

78

Due to a change in the definition of official reserves, the level of reserves since 1992 cannot be directly compared with earlier years. Until September 1992, official reserves included the foreign exchange holdings of the Bank of China. Subsequently tile definition of official reserves was changed to cover only the foreign exchange assets of the PBC. Based on the “old” broader definition, the import cover of reserves (in terms of imports of goods and nonfactor services) was close to 9 months in the early 1980s, fell to around 4–5 months in the mid–1980s, and rose again in 1990–91.

79

Developments in China’s current account position in recent years are difficult to interpret due to changes in the coverage of some components of the services and income account in 1995 and 1996, which were not consistently applied to earlier years. In particular, since 1995, efforts have been made to include an adequate estimate of reinvested earnings of FFEs in investment income. Moreover, net errors and omissions in the balance of payments, which also include unrecorded current account transactions, have risen significantly in recent years. While these data problems complicate the assessment of developments in the current account from one year to the next, staff estimates suggest that they do not significantly alter the broad picture of the average current account position in recent years.

80

FFEs include contractual and equity joint ventures and purely FFEs.

81

The reforms in the exchange and trade system are described in detail in the background paper on external sector opening.

82

The deadline for the phasing out of the exemptions, originally scheduled for 1997, was later extended to June 30, 1998.

83

The figure for the first quarter of 1997 refers to customs data and is thus not fully comparable to the annual figures, which are based on balance of payments data. In 1996, the trade surplus in the balance of payments exceeded the customs-based surplus by $1.7 billion.

84

Export values in terms of U.S. dollars, customs basis.

85

Staff estimates of the trade balance on a balance of payments basis derived from customs data. Exports and imports of domestic enterprises are defined residually as total exports (imports) minus exports (imports) of FFEs.

86

China’s trade statistics do not include data on volumes and unit values. The discussion of export and import developments in this section is, therefore, based on values in terms of U.S. dollars (customs data). All growth rates refer to changes relative to the same period in the previous year.

87

Under the retention quota system, domestic firms were obliged to convert their export earnings at the official exchange rate but received retention quotas equivalent to a certain proportion of their foreign exchange earnings, which could be traded in the swap market. Thus, the exchange rate faced by these firms prior to the unification of the exchange market was a weighted average of the official rate and the more depreciated swap-market rate, and the size of the effective depreciation implied by the unification depended on the size of the retention quotas. FFEs were not subject to the retention quota system and were allowed to retain the full amount of their export earnings.

88

Zero rating of exports under the VAT implied that exporters could claim a refund of the VAT paid on inputs. FFEs established before January 1, 1994 were exempt from the VAT on exports and thus were not eligible for a refund. The new regulations included, however, a provision that during a transitional period “old” FFEs could claim a refund if the VAT tax burden faced under the new system was higher than under the old system.

89

According to the statistics on VAT rebates, the refunds claimed by exporters exceeded actual VAT payments on inputs for export production.

90

Processing trade covers exports based on “processing and assembling” and “processing with imported materials,” as defined in Chinese customs statistics. In the balance of payments, the first category is included only on a net basis in the services account.

91

The discrepancies in bilateral trade statistics resulting from differences in the treatment of exports shipped through Hong Kong are discussed in “People’s Republic of China-Background Paper,” (SM/95/44, Supplement 1, 3/9/95).

92

While the growth of imports related to the establishment of new FFEs depends on the growth of FDI inflows, increases in FFE exports and imported inputs for export production are functions of the growth of the stock of FDI. Both the growth of FDI inflows and the growth of the stock of FDI peaked in 1993 and moderated in subsequent years.

93

As imports of domestic enterprises are derived residually, they also include imports of agricultural goods and consumer goods.

94

Strictly speaking, the income elasticity of domestic (non-FFE) imports should be measured in terms of non-FFE growth. Given the rapid growth of FFE output, the latter has been somewhat lower than total GDP growth in recent years.

95

The trade system is discussed in detail in the background paper on external sector opening.

96

The coverage of “investment income, debits” was changed in 1995 to include reinvested earnings of FFEs. At the same time, the coverage of “other services, debits” was broadened. These changes appear to have accounted for most of the sharp increase (close to $20 billion) in payments on services and income in the balance of payments in 1995. In 1996, the coverage of “other services, credits,” which includes receipts from processing trade, was broadened. Balance of payments statistics for earlier years were not revised to take account of these changes, resulting in breaks in the series.

97

These estimates are based on the stock of FDI and an assumed profit rate that is in line with the one implied by the balance of payments data for 1995.

98

While the data on FDI inflows may be somewhat exaggerated due to “round-tripping” (unrecorded capital outflows by Chinese investors which return as FDI to benefit from the special incentives for foreign investors), the general picture of a strong surge in FDI seems nevertheless accurate.

99

See IMF, “World Economic Outlook,” May 1997 (Washington: International Monetary Fund), Table 10.

100

Data on the breakdown of FDI inflows by source are not yet available for 1996.

101

The role of these zones and the incentives they offer are discussed in the background paper on external sector opening.

102

The background paper on external sector opening contains a summary of present capital account regulations.

103

Foreign investment in the Chinese stock market is limited to special types of shares, so-called “B” shares, which are only traded by foreigners.

104

Balance of payments statistics on debt-creating flows suggest average annual increases in total external debt of some $3.5 billion since 1983.

105

The stability of the nominal effective exchange rate is attributable to the large weights of the U.S. dollar and the Hong Kong dollar (which is linked to the U.S. dollar) in China’s effective exchange rate index.

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Cover IMF Staff Country Reports
China: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 1997: Issue 071
Publisher:
International Monetary Fund
ISBN:
9781451807738
ISSN:
1934-7685
Pages:
99
DOI:
https://doi.org/10.5089/9781451807738.002

China: Different measures of inflation

(12-month change in index; in percent)
CHART 1

CHINA FACTORS CONTRIBUTING TO GROWTH OF RESERVE MONEY, 1993–96
CHART 2

CHINA FACTORS AFFECTING THE GROWTH OF BROAD MONEY, 1993–96 1/
CHART 3

CHINA BALANCE OF PAYMENTS DEVELOPMENTS, 1982–96

(In billions of U.S. dollars)
CHART 4

CHINA EXPORTS AND IMPORTS, 1993–96 1/

(In billions of U.S. dollars)
CHART 5

CHINA SHARE OF WORLD EXPORT MARKETS, 1980–96 1/
CHART 6

CHINA EXCHANGE RATE DEVELOPMENTS, 1988–1997 1/