China Reacts in Extraordinary Times

Published: 2008-10-30

Cover story, issue 391, Oct. 27, 2008
Translated by Zuo Maohong
Original article:
[Chinese]

"The most important thing when a global financial storm breaks is confidence. Confidence is more important than gold or money," said Chinese premier Wen Jiabao at his meeting with German Chancellor Merkel and German entrepreneurs in Beijing on October 23.

Over the past six weeks, the Chinese government has pushed a historic series of stimulus policies to temper the financial maelstrom that ensued after the collapse of Lehman Brothers.

The string of measures is reminiscent of 1998, when the last financial crisis hit Asia. That time, China pulled out of a recession with fiscal stimulus measures.

Wen's Ten Policies
"Within five days, we plan to launch all policies among the ten that are ready. Some have called for cooperation among several ministries, but it's been going smoothly," an official from the Ministry of Finance (MOF) told the EO last week during a break between meetings.

"The ten" he mentioned referred to ten measures agreed on at the October 17 State Council meeting chaired by Premier Wen. At the meeting, the State Council decided to release as soon as possible ten new policies on tax, credit, foreign trade and more to ensure stable economic growth.

A series of polices were released in the following week. On October 20, the National Development and Reform Commission announced it would greatly raise the minimum purchase price for grain, subsidies for farmers, and investment in agriculture in 2009.

On October 22, the MOF cut the contract tax from 1.5% to 1% for first-time home buyers of units with floor space of no more than 90 square meters. The stamp tax and value-added tax on home sales were abolished.

The People's Bank of China (PBOC), China's central bank, that day announced through an online memo that the minimal down payment required for first-time home buyers of units with a floor place no more than 90 square meters would be reduced to 20% from the previous 30%.

The next day the PBOC made another announcement that it would strengthen support for credit to small and medium sized companies, and promised to simplify credit procedures to allow small companies to secure loans more easily.

On October 24, the Ministry of Railways (MOR) raised the total investment in railways during the 11th Five-year plan period (2006-2010) to RMB 2 trillion from the previous RMB 1.25 trillion.

Academics have labeled the policy shift as a change from previously tight fiscal polices to active ones. In an interview with a leading Chinese business magazine Caijing, former finance minister Xiang Huaicheng agreed that it was necessary to "reset" fiscal policies.

A Time for Change
The premise for such drastic policy changes during October was set by September 13, the second day of the traditional Chinese Mid-autumn holiday.

That day, an impromptu three-hour meeting was held at the central bank, where officials and academics discussed one topic – was it time to cut the interest rate and reserve requirement; and if yes, by how much?

"Everyone agreed to cut. But it took a long time to decide on the second question," one participant recalled to the EO.

The next day, news came from Wall Street that the 158-year old investment bank Lehman Brothers went bankrupt. A day after that, the central bank cut its benchmark interest rates for the first time since 2003.

The rate-cut reaction was an extraordianry one. I was the only one who believed China would cut its interest rates and reserve requirement before the end of the year, but even I never expected it would cut the requirement ratio by a full percentage point," said Gong Fangxiong, chief economic analyst of JP Morgan.

In previous weeks, officials and academics were still arguing about the priority of ensuring growth and preventing inflation. Zhou Xiaochuan, governor of the PBOC warned that inflation might rebound and even mentioned the possibility of raising interest rates.

"The economy might drop to an extent beyond our imagination," said Pan Xiangdong, chief macro economic analyst at Everbright Securities, in his report after the macro economic data for August was released. In August, the consumer price index (CPI) dropped to 4.9%, and the industrial added value growth slowed to 12.8%.

While Beijing was still celebrating a successful Olympic hosting in a fresh and crisp September, an economic storm was creeping nearer.

After the bankruptcy of Lehman, Merrill Lynch sold itself to Bank of America. AIG (American International Group) was nationalized by the Federal Reserve. Morgan Stanley and Goldman Sachs abandoned their investment bank status and became bank holding companies. Overnight, five independent investment banks in Wall Street disappeared.

In its report on September 17, the Chinese International Capital Corporation commented that the collapse of the five meant the end of an era. Meanwhile, Jin Yanshi, Chief economist at Guojin Securities, remarked that a real crisis had yet to come.

On the night of September 18, the Ministry of Finance announced to abolish the stamp tax on buying shares. Later, the rumor that Central Huijin would buy shares in three state-owned banks was officially confirmed.

Then, on the night of October 8, the central bank cut interest rates and reserve requirement again, just several hours before the Fed. Central banks in Europe and Japan consecutively made similar announcements.

Not Like 1998
Since September, the National Development and Reform Commission (NDRC) had been urging local government to submit investment plans. "Railway and power grid should be the focus," said a source close to the Commission.

However, it would be unrealistic to launch investments as massive as those done in 1998, an NDRC official told the EO. He estimated the surplus revenue this year at RMB 1 trillion, and suggested that if just 5% of that could be allocated for investment it be "pretty good".

Officials who had experienced the last round of expansive fiscal policies were especially prudent. "We can't repeat what we did in 1998. At that time, we made huge investment in fixed assets to guarantee GDP growth. The result is that though GDP and exports grew, consumption continued to shrink," said Liu Shangxi, deputy director of the MOF's research institute.

That year, the MOF issued RMB 100 billion of long-term treasury bonds for construction projects.

Official date showed that by the end of 2000, altogether 6,620 government-invested projects were launched, and the total investment amount in fixed assets had reached RMB 1.5 trillion.

Purportedly, between 1998 and 2000, China had a weekly investment of USD 2 billion mainly in highways, railways, airports and grain stock houses.

Liu suggested to invest more in projects closely related to people's livelihoods, such as housing and rural hospitals. Consumption could only be stimulated when people's welfare was guaranteed, he said.

Standard Charter's senior economist Stephen Green agreed that China would not follow in the steps of 1998. This time, he said, China might have to invest more to achieve the same effect as in 1998, because investment in education, health and social securities, which took up a big portion in its total investment, drew little traction with private capital.