res brief china

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Published 28 March 2010

Project on

MONITORING AND ANALYSIS

OF BUDGETS IN

MAHARASHTRA STATE

RESEARCH

BRIEF - 3

THE FISCAL STIMULUS PACKAGE IN CHINA

Vineet Kohli

We have given priority to undertakings

concerning people's well-being in theeconomic stimulus measures and pooledresources to accelerate relevant keyprojectsWe are making every effort toaddress issues concerning the immediateinterests of the people, such as employment,medical care, housing, old-age support andenvironmental protectionChina has alsointensified efforts to improve the socialsafety net and has substantially raised socialsecurity benefits.

(Hu Jintao, Chinese President, 2009)

The Context

The world economy is currently facing themost severe slowdown since the 1930s.According to the most recent data released bythe IMF, the world GDP fell in absolute termsby nearly 1.1 per cent between 2008 and 2009.The economic slowdown in the G7 economies

was much more severe, and their GDP fell inabsolute terms by 3.6 per cent between 2008and 2009. The most disturbing trend emergesfrom central and eastern Europe, where theGDP shrank by 5 per cent between 2008 and2009.

Amidst this gloom, the only ray of hopeappears to be developing Asia, where the GDPgrew at 6.2 per cent between 2008 and 2009,though at a slower rate than between 2007and 2008, when the GDP grew at 7.6 per

cent. Within developing Asia, the strongestperformer is its largest economy China that recorded a growth rate of 8.5 per centbetween 2008 and 2009. The performance ofother East Asian economies was not asremarkable; Malaysia and Thailand remainedin the negative growth territory and GDPgrowth in India fell from 7.4 per cent between2007 and 2008 to 5.4 per cent between 2008and 2009.


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China has shown greater resilience to thecurrent economic downturn than any othereconomy in the world. This is surprising since

the Chinese economy is highly export-orientedand a very large share of its exports aredirected towards the US and Europe, whichare the epicenters of the current crisis. Acomparison with India would be illustrative. In2008, exports constituted 23 per cent ofIndias GDP and 36 per cent of Chinas GDP.Yet, Indias GDP growth fell by 2 percentagepoints in 2009, whereas Chinas GDP growthfell by only 0.5 percentage points.

The remarkable success of China in insulating

itself from the global downturn can beascribed to its massive fiscal stimulus package,towards which we now turn our attention.

Why is a Fiscal Stimulus Required?

Episodes of economic downturn involve asharp decline in private spending on goodsand services. Firms become pessimistic aboutfuture and cut down their spending on capitalgoods. Similarly, households become

apprehensive about their employment andincome, and cut down their spending onconsumer goods. The net result of this declinein private spending is lower production andemployment in the economy, which onlyreinforces the initial decline in privatespending.

Fiscal stimulus involves the use of governmentbudget, either through tax cuts or throughdirect spending, to shore up the level ofdemand in the economy. Governments cancounteract the decline in private spending byshoring up their own spending, such as bybuilding new roads or hospitals. Governmentscan also try to stimulate private spending byreducing taxes and putting more disposableincome in the hands of corporates andhouseholds. However, tax cuts are not afoolproof way of increasing spending in theeconomy because the private sector maysimply save this increase in disposable incomeinstead of spending it on goods.

Chinas Stimulus Package in a ComparativeContext

While the rationale for providing a fiscalstimulus is straightforward, most countrieshave struggled to put together a reasonablylarge stimulus package. In these countries, thebarriers to effective stimulus appear to belargely political. For instance, conservativeelements within the US political system have vehemently opposed any plan for the revivalof the US economy through a pro-active fiscalpolicy. The US administration was forced togive in to the demands of such elements bykeeping its stimulus package mild and, to the

extent possible, administering even thismeager stimulus through tax cuts rather than

direct spending.1

A feature of policymaking in China, on theother hand, appears to be the near absence ofpressure from financial conservatives. Chinacould, therefore, respond to the current crisis with amazing alacrity by putting together avery large fiscal stimulus package of nearly 4trillion Yuan (or US$ 585 billion) inNovember 2008 itself. In fact, when measured

relative to GDP, Chinas fiscal stimulus is byfar the largest in the world: 12.3 per cent ofGDP compared to only 5.5 per cent in theUS.2

1 Total size of the US stimulus package is US$ 787billion, of which US$ 288 billion is in the form of taxcuts.

2 A large part of the US stimulus is neutralized by thedecline in tax revenues of the local and stategovernments, who would, as a result, be forced tocut down on their expenditure (or raise new taxes).Local and state governments are prohibited fromrunning budget deficits. Additionally, nearly US$ 146billion of the stimulus amount in the US would bespent after 2010, and therefore does not aid thecurrent recovery. After taking these factors intoconsideration, according to one calculation, the sizeof the US stimulus falls to US$ 126 billion annuallyfor 2009 and 2010. See Dean Baker and RivkaDeutsch (2009), "The State and Local Drag on theStimulus," CEPR Reports and Issue Briefs 2009-17,Center for Economic and Policy Research (CEPR),

Washington.


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Moreover, the actual size of stimulus in Chinais larger than the one announced in November2008. As a media report recently clarified:

Apart from the 4-trillion-yuan package,China will cut tax by 600 billion yuan,raise the old-age pension for retired

workers, hike the salaries of 12 millionteachers, increase farmers income and

provide more subsidies for them.3

Additionally, China is planning to undertakethe expenditure of nearly US$ 125 billion till2011 as a part of an overall programme touniversalize health by 2020. This expenditure was also not accounted for in the stimuluspackage announced in November 2008. If onlythe tax cuts and half of the total amountmeant for extension of healthcare are added,total size of Chinas stimulus package for2009 and 2010 increases to US$ 5.02 trillionor US$ 757 billion. There is, in other words, astrong likelihood that Chinas stimuluspackage is greater than that of the US, even inabsolute terms.

Composition of Stimulus Spending

The largest component in Chinas stimuluspackage is directed towards majorinfrastructure projects (Table 1). According toreports, most of the infrastructure spending isdirected towards transportation and theelectricity grid. Within transportation, thefocus is on the construction of new railwaylines, expressways and airports. A very largeamount is also being spent on relief andreconstruction in the earthquake-devastatedSichuan region.

Almost 10 per cent of the stimulus package isdirected towards low-cost housing. Thisinitiative would include construction of newhouses as well as the upgradation of shantytowns.

Within rural development, which accounts for9.25 per cent of the package, the focus is on

3 See http://news.xinhuanet.com/english/2009-03/13/content_11004933.htm

infrastructural items such as roads, ruralelectricity, irrigation and water conservancy,provision of safe drinking water and

electricity. A significant amount is alsoallocated for industrial upgradation, newtechnology and environment. The expenditureon social services would appear small, but itshould be noted that much of the increase inhealth expenditure is placed outside thestimulus package announced in November2008.

Financing the Stimulus

Out of the 4 trillion Yuan stimulus package,the central government would reportedlycontribute 1.18 trillion Yuan and localgovernments another 1.23 trillion Yuan. Rest ofthe increase in expenditure is supposed totake the form of bank loans to State OwnedEnterprises (SOEs).4

To ensure increased availability of credit forstimulus financing, the State council increasedcredit quotas of the State Owned Banks(SOBs) and directed them to increase lending.

In fact, Bank of China and Agricultural Bankof China signed co-operation agreements withthe railway ministry to support the upgrade ofrailway infrastructure. Thus, a large part ofthe observed increase in social and economicinfrastructure spending is being financed bythe banking system. SOEs have thereforeacquired a special role in the recovery.

Examining the Recovery

The economic recovery in China is clearlyinvestment-led. While the GDP grew by 8.7per cent between 2008 and 2009, fixedinvestment grew by 30.5 per cent.Consequently, the share of investment in GDPincreased from 48.2 per cent in 2008 to 57.9per cent in 2009.

4 Economist Intelligence Unit (2009), Chinas StimulusPackage: A Six Month Report Card.


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The increase in fixed investment has been ledby the SOEs. Fixed investment by SOEsincreased by 35 per cent between 2008 and2009. Consequently, the share of SOEs in totalfixed investment increased from 43 per centin 2008 to 44.6 per cent in 2009.

On the other hand, Chinas trade surplus fellin this period from US$ 298 billion in 2008 toUS$ 196 billion in 2009. This happenedbecause Chinas exports fell at a faster ratethan its imports between 2008 and 2009. The

fall in the trade surplus implies that othercountries have also gained from Chinasstimulus package.

Additionally, retail sales of consumer goodsincreased by 15 per cent between 2008 and2009. Here, one must note the presence of therural home appliance subsidy programmethat was initiated in 2009. Under thisprogramme, subsidy is offered to ruralresidents for the purchase of home appliances.The subsidy disbursed under this programme

was not accounted for in the 2008 stimuluspackage.

To further investigate the nature of recoveryin the Chinese economy, we have examinedthe composition of fixed investment in Chinain 2008 and 2009 (Table 2). Total fixedinvestment in China increased by 4.47 trillion Yuan between 2008 and 2009. The tertiarysector accounted for 2.7 trillion Yuan (ornearly 60 per cent) of this increase in fixedinvestment between 2008 and 2009. Within

the tertiary sector, the strongest increase ininvestment was in transportation, storage andpost, which accounted for nearly 28 per centof the total increase in tertiary sectorinvestment. Thus, major infrastructuralprojects have received the highest prioritywithin the stimulus package.

Real estate and water conservation, andenvironment and public facilities were theother two major destinations of fixedinvestment. Production and supply of

electricity, gas and water also played animportant role, accounting for nearly 6.5 percent of the increase in fixed investment. Wemay recall that construction and upgradationof grids was an important component of themajor infrastructural projects towards which1.5 trillion Yuan were set aside in the package.In sum, the economic recovery appears to bein consonance with the priorities set in thestimulus package.

Misgivings about the Package and theRecovery

There are two misgivings about the nature ofeconomic recovery in China. First, it is arguedby some that the current recovery is based onmassive speculation in real estate and stockmarkets, fed by a nearly 30 per cent creditgrowth between 2008 and 2009. When thisbubble bursts, the Chinese banking system would also go under. In the doom scenario,the banking crisis in China would cause a long

Table 1 Composition of the Chinese Fiscal Stimulus Package, in billion Yuan and %

Item of spendingAmount to be spent

(in billion Yuan)

Share in total

amount (%)Major Infrastructure 1500 37.5

Post-Quake Reconstruction 1000 25

Low Income Housing 400 10

Rural Development 370 9.3

Industry and Technology 370 9.3

Environment 210 5.3

Health, Education and Culture 150 3.8

TTTTOTALOTALOTALOTAL SSSSPENDINGPENDINGPENDINGPENDING 4000400040004000 100.0100.0100.0100.0

Source: Compiled from http://blogs.wsj.com.


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recession similar to the one experienced by Japan in the wake of its banking crisis in1990s. Zhang Hong, for example, warned inhis column in The Guardian:

The fast-rising stock and real estatemarkets suggest a large portion of thenew loans have been used in speculativeinvestments, causing another round ofasset bubbles in China. This wont muchhelp China's real economy. When thebubble bursts, the banks will be sitting ona huge amount of bad debt. China risksrepeating the same game as America after

the dotcom boom and burst.5

Secondly, many observers see the currentrevival as based on inefficient investments bystate owned enterprises (SOEs), and thusdetrimental to the long-term interests of the

Chinese economy. Credit directed towardsSOEs would only increase the Non-PerformingLoans (NPLs) of the banking system. Since thegovernment may have to bail out many ofthese banks, the current recovery would be adrag on government finances in the future.SOE-led revival may therefore severely

5 Zhang Hong, Too early to hail China's stimulussuccess, TheGuardian, 28 August 2009.

compromise the long term growth prospects

of the Chinese economy.6

Let us examine these two argumentssequentially. Going by the number ofnewspaper stories and anecdotal evidenceabout booming property markets in China,

there must be some truth in the claim thatChina is currently witnessing a real estatebubble. However, there is a need to temperthis view with some hard facts.

First, real estate investment forms only 16 percent of the increase in total fixed investmentbetween 2008 and 2009. Even if fixedinvestment in real estate had remainedconstant, total fixed investment in China would still have grown by 25 per centbetween 2008 and 2009.

Secondly, public housing is stipulated to form10 per cent of the stimulus packageannounced in November 2008. Since a part ofthe increase in real estate investment is likelyto have been directed for this purpose, itwould be wrong to treat the entire increase in

6 The view that SOEs act as a drag on banking systemand government finances can be found in Wing Thye

Woo (2006), The Structural Nature of Internal andExternal Imbalances in China, Journal of ChineseEconomics and Business Studies, February.

Table 2 Increase in Fixed Investment in China, 2008 to 2009, in 100 million yuan and %

Sector of investment Amount in 2009(in 100 mn yuan)

Growth,2008-09 (%)

1.1.1.1. TotalTotalTotalTotal investmentinvestmentinvestmentinvestment 44742447424474244742 30.530.530.530.5

2.2.2.2. PrimaryPrimaryPrimaryPrimary sectorsectorsectorsector 1121121121123333 49.949.949.949.9

3.3.3.3. SecondarySecondarySecondarySecondary sesesesectorctorctorctor 17389173891738917389 26.826.826.826.8

Production and supply of Electricity, Gas and Water 2891 27.3

Manufacturing 12431 26.8

4.4.4.4. TertiaryTertiaryTertiaryTertiary sectorsectorsectorsector 26918269182691826918 33333333.0.0.0.0

Transportation, Storage and Post 7581 48.3

Railway transport 2749 67.5

Real estate 7148 19.9

Water Conservation, Environment and Public Facilities 5537 45.1

Health, Social Security and Social Welfare 624 58.5Education 962 42.4

Source:National Bureau of Statistics, China.


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real estate spending as being speculative innature.

Thirdly, even in December 2009, sales priceindex of buildings in 70 medium and largecities across China was only 7.8 per centhigher than its December 2008 level not anawful lot for a country enjoying an annualgrowth rate of 8.7 per cent.

Fourthly, while the credit growth figure of 30per cent is extremely high by any standard, itmay not be fair to treat the entire growth incredit as being driven by speculative pursuits.After all, nearly 40 per cent of the financing

of the stimulus is supposed to come from thebanking system.

Of course, all the above is not to deny theexistence of any problem in Chinas real estatemarket. Real estate prices were probably toohigh even before the recovery started inChina. However, in the light of facts presentedhere, it would also not be an exaggeration tostate that the recovery in China would havebeen on a strong footing even in the absenceof the bubble.

As far as the alleged inefficiency of SOEs isconcerned, two points need to be made. Firstof all, a large part of the SOE investment is oninfrastructural items, which play a key role ineconomic development. It would, therefore, bea mistake to look at the lower profitabilityratio of SOEs and conclude that they areinefficient. The SOEs produce goods that aresocially useful even if these social benefitscannot be captured as private profits by firmsthat produce them.

Secondly, Dic Lo (2005) has pointed out that,historically, pre-tax profit rate in Chinas SOEshas not been lower than the average profitrate in the Chinese industry.7 The profit ratewas higher than the average in the 1980s andslightly lower than the average in therecessionary conditions of the late-1990s.

7 Dic Lo (2005), China, the East Asian Model andLate Development, Paper Presented at theConference on Comparative Political Economy ofGlobalisation, SOAS, London.

Moreover, the gap between pre- and post-taxprofit rates is higher in case of SOEs. Loconcludes that,

In contrast to the allegation that SOEshave been a drag on the economy in theform of taking up state subsidies andgenerating bad loans for state banks, thedistributive relationship between the stateand SOEs has been characterized bysurplus transfer from the latter to theformer.

The Problem of Large Capital Flows

Since the current recovery in China is drivenby debt financed investment by SOEs, it isimportant to examine the macroeconomicconditions under which this strategy issustainable. As the experience of the EastAsian countries during the crisis of 1997 and1998 has amply demonstrated, the corporatestrategy of high debt and high investment issustainable only when there are extensivecontrols on capital flows. A sudden outflow ofcapital can completely wreck the highlyindebted domestic firms by necessitating a

sharp rise in domestic interest rates. Theproblem can be especially severe if firms haveborrowed in foreign currency and the countryis forced to devalue domestic currency due tocapital outflow.

One can argue that, unlike all countries hit bythe crisis of 1997 and 1998, China has a verylarge current account surplus and a recordlevel of forex reserves for any country till date.Here, it needs to be kept in mind that Chinastrade surplus has eroded at a very fast rate in

the last one year and looks all set to fallfurther in future. In the longer run, therefore,the conflict between capital mobility and thehigh debt-high investment model is likely tobecome binding for China as well.

It is precisely in this direction that someproblems have become visible in the last year.China accumulated nearly US$ 485 billion of


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foreign exchange reserves in 2009.8Reportedly, Chinas trade surplus and net FDIflow in 2009 were US$ 196 and US$ 46.7

billion respectively. This suggests that a verylarge chunk of foreign exchange accumulationin 2009 was on account of hot money flows.

This large inflow of hot money, occurring at atime when the trade surplus is shrinking fast,may end up presenting difficulties in future. When this capital flows out, China may beforced to raise its interest rates therebythrowing a spanner in the works of economicgrowth led by debt-financed investment.

Clearly, therefore, the long-term sustainabilityof the current growth path depends on policychoices China makes with regard tointernational finance. If the deluge of foreigncapital continues, the Chinese governmentwould need to consider some curbs on inflowof speculative capital into its economy.

In Conclusion

Large and timely fiscal stimulus measures

implemented by China have ensured that thedownswing in its economy has neither beensteep nor painfully long. A good point ofcontrast would be the United States, whereGDP growth hovered in the negative territoryfor a good part of 2008 and 2009.

It is true that the Chinese recovery has beenaccompanied by some irrational upswings inreal estate and stock markets. However, itwould be a mistake to view China as being abubble-ridden economy akin to Japan in the

1980s or the US prior to the recent housingmarket crash.

At a deeper level, Chinas ability to undertakea large fiscal stimulus package shows therelative autonomy of the Chinese governmentfrom the pulls and pressures of financecapital. In other countries, especially the US, vested interests in the financial sector have

8 The data are from the State Administration ofForeign Exchange, Beijing.

opposed any major programme of revivalthrough government spending. Governmentintervention was acceptable to these interests

only to the extent that it involved bailing thebanks out.

On the other hand, the financial system inChina has played an important role in theexecution of the governments stimuluspackage. Despite some adverse trends in itsfinancial markets, China still stands out as acountry that can direct its financial sectorresources towards goals of nationaldevelopment.

(Vineet Kohli is Assistant Professor at the TataInstitute of Social Sciences, Mumbai.Corresponding email:[email protected])


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This Research Brief was prepared at the School of Social Sciences as part of the project titledMONITORING AND ANALYSIS OF BUDGETS IN MAHARASHTRA STATE, internally funded bythe Research Council of the Tata Institute of Social Sciences, Mumbai. Corresponding email:[email protected].

Research Briefs are envisaged to be short and structured summaries on important research andpolicy issues. The opinions and comments in the research briefs are the personal views of theauthors, and do not reflect the official positions of the institutions with which they areassociated.

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