Wednesday 25 March 2009

Warming Up to China’s Economic Stimulus

Beijing’s faith in 8 percent GDP growth for 2009 is grounded in a 4 trillion yuan stimulus package now starting to gel.

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Warming Up to China’s Economic Stimulus

Beijing’s faith in 8 percent GDP growth for 2009 is grounded in a 4 trillion yuan stimulus package now starting to gel.

Zhang Hong, Caijing
25 March 2009

”Written in stone” is how Chinese leaders are describing their goal for an 8 percent GDP growth rate in 2009, even while other economies tumble like boulders in the global financial landslide.

“In a developing country like China, with a population of 1.3 billion, maintaining a certain economic growth pace is needed to provide urban and rural jobs, raise income levels, and maintain social stability,” Premier Wen Jiabao said while delivering a government report March 5 to the National People’s Congress (NPC) in Beijing.

At the time, few analysts dared to agree with Wen’s prediction of an 8 percent growth rate. Some said it would rise no higher than 5 percent.

Many pessimists wondered how China, whose growth largely depends on overseas export demand, could surge forward while customers in the developed world experience what that the International Monetary Fund said would be GDP shrinkage this year.

Wen offered a philosophical response at a press conference as the NPC closed: “If our heart is warm,” he said, “the economy will be warm.”

Beijing’s answer to skeptics hinges on a troika for economic growth -- consumption, investment and exports.

No one expects much luck on the export front. And it’s hard to imagine significant growth in domestic consumption, at least in the short-term, since household incomes are limited and Chinese consumers like to save.

That leaves investment as the only major arena with the potential for generating the degree of warmth Wen expects – 8 percent growth – despite a global financial freeze.

Clarifying the Stimulus Plan

At the core of Beijing’s investment strategy is a two-year, 4 trillion yuan economic stimulus plan announced by the government in November.

“Investment expansion is one of the most direct and effective ways to stimulate economic growth,” said Zhang Ping, chairman of the National Development and Reform Commission (NDRC), at an NPC press conference March 6.

The plan calls for the central government to put 1.18 trillion yuan into the pot, with local governments and private sources providing the rest. Beijing’s spending already began with a 104 billion yuan outlay in the fourth quarter 2008. Its expenditures are to include another 487.5 billion yuan this year and 588.5 billion yuan in 2010.

How much that cash will represent fresh spending? All of it, according to Wen.

“This 1.18 trillion yuan is completely newly added,” Wen said March 13 at a press conference in response to public concerns over the investment. He said the spending will include investments in new housing for low-income families, as well as money spending for some roads and railway projects previously proposed as part of the government’s most recent five-year plan.

Projects already on the drawing board had to be included. “How could we otherwise affirm so many infrastructure construction projects within such a short period of time?” Wen asked.

But since the rest of the funds -- 2.82 trillion yuan – are to be raised through local governments and the private sector, a follow-up question is whether the central government’s input can really trigger such huge outlays by stimulus partners.

Under the plan, certain investment projects will require set percentages of input from the central government. For instance, the central government is to shoulder two-thirds of the capital responsibility for school building, as well as provide subsidies of 300 yuan to 400 yuan per square meter for low-income housing construction in central and western parts of the country.

Investments are to mainly target seven sectors, with railways, roads, airports and waterworks accounting for the bulk of the share and 1.5 trillion yuan. Post-earthquake reconstruction mainly in Sichuan Province will receive 1 trillion yuan. Low-income housing, rural civilian infrastructure projects, and public welfare programs will require a combined 92 million yuan.

NDRC’s Zhang said the original stimulus plan announced by the State Council include slight adjustments to investment targets and a major reshaping of investment allocations. The changes were made based on varying opinions from the public, he said.

One area of heated debate is over the 45 percent share of the spending devoted to infrastructure. Critics say that’s too much. Some who object to infrastructure’s dominance point out that a similar government investment plan after the 1998 Asian financial crisis led to redundancies and overbuilding in cities.

“Intense investment results in low returns and has little effect on mobilizing employment,” argued the deputy director of the economic institute at the China Academy of Social Sciences, who is also named Zhang Ping.

According to the academy’s Zhang, urbanization is the key to boosting domestic consumption. And a viable target for investment is low-income housing construction, as it not only improves living standards but also speeds up urbanization. This investment focus is not the largest in terms of spending but was listed first on the government’s investment agenda.

Borrowing Strategy

Much of the money will be borrowed. The central government’s Ministry of Finance plans to enlarge the issuance of government bonds by 570 billion yuan compared to 2008 to help close a funding gap of up to 750 billion yuan this year. NDRC estimates that local governments will need 240 billion yuan in loans to meet their 540 billion yuan in total capital requirements in 2009, and another 260 billon yuan in 2010.

The burdens for local governments will be especially heavy, since prime revenue sources are falling due to a real estate market recession that’s reduced land leasing income and tax receipts.

Since Chinese law does not allow local governments to directly issue bonds, the central government plans to issue bonds on behalf of the locals. Altogether, the Ministry of Finance this year plans to raise 200 billion yuan through bonds for provincial governments.

A breakdown of the 200 billion yuan bond plan has not be released. Jia Kang, a senior researcher at Ministry of Finance, said Beijing will adjust bond programs according to the needs spelled out when local governments file credit requests.

One obstacle is the uneven repayment abilities of various local governments. Less developed areas may have a more urgent need for infrastructure projects but lack capacity to repay debt. In similar situations in the past, some local governments were buried in debt until the central government intervened with a clean-up project. Questions about this strategy have now resurfaced.

“Is it appropriate for underdeveloped and remote areas to raise debt to finance their infrastructure projects?” asked Jia. “If it is necessary, should the central government help them pay back principle and interest?”

But local governments have other borrowing options. The city of Ningbo, has raised money to supplement the central funding to build a rural health care center. And Wang Renzhou, an NPC representative and NDRC director for Ningbo, told Caijing that local governments can raise money, as an alternative to issuing bonds via the central government, through government-owned companies by issuing corporate bonds or stock. These kinds of corporate bonds are often called “city construction investment bonds,” and often attract investors due to their low risk of default.

Hebei Construction Investment is an example of a government-owned policy investor with borrowing clout. Its general manager Wang Yongzhong, who is also a member of the China People’s Political Consultative Conference (CPPCC), told Caijing his firm is responsible for raising money to build express railways in Hebei Province.

“We have filed a report to Beijing for issuing 2 billion yuan in bonds in the first quarter,” said Wang.

Beijing’s attitude is to encourage local financing platforms, particularly for roads and power grid renovation projects--such ones not immediately profitable. NDRC’s Zhang said March 16 that 45 corporate bonds programs have been launched since the fourth quarter 2008 to raise 130 billion yuan.

Also, these enterprises controlled by local governments can borrow from commercial banks, which have plenty of room to expand lending. According to a measure now being crafted by Beijing authorities, commercial banks will be able to issue credit to raise the capital base for investment projects. Once the project accumulates an adequate capital base, it can seek further loans.

Banks have already been heralded to help China boost domestic consumption. Beijing set a goal for banks to write at least 5 trillion yuan in new loans this year. Central Bank Gov. Zhou Xiaochuan told the NPC said exceeding the 5 trillion mark “is very important.”

Beyond the Stimulus

The 4 trillion yuan plan is only one part of the government’s push to bolster China’s economy.

“We have prepared solutions for more daunting difficulties, and can propose new economic stimulus policies at any time as needed,” Wen said at the NPC press conference March 13.

Jia told Caijing that if economic data for May and June do not indicate that the economy will turn around in the second half of the year, a new round of stimulus spending should be launched.

Jia said the government may have to “adopt a new expansion plan to further bolster economy.”

Wen said the 4 trillion yuan package was “not understood fully.” Actually, he said, it’s one element in a basket of plans.

Also in the basket are plans for revitalizing industries, as proposed by the Politburo on February 23. Starting this year, China will adopt a new value-added tax (VAT) policy and raise tax rebates for exports, as well as implement favorable tax policies for small- to medium-sized, real estate and securities trading.

According to UBS Securities China chief economist Wang Tao, tax revenues this year will fall by 300 billion yuan, while the fiscal stimulus is expected to contribute to 3 percent of GDP.

Already, some aspects of the stimulus plan have been revised. NPC delegates were told that infrastructure investments would be cut by 300 billion yuan from the initial plan, while spending for low-income housing would rise to 400 billion yuan from the original 280 billion yuan.

The stimulus package “is actually a process of give and take,” said the NDRC’s Zhang. “Many projects, perhaps, will see changes in practice as situations are not unchanged.

Long-Term Trajectory

The bulk of the 4 trillion yuan will be spent on projects whose contractors hail from state-owned companies in the steel, cement and energy sectors. Light industries – those hardest hit by the global recession – expect few benefits.

“The state investment plan is sunshine for heavy industries and SOEs, but can not shield light industries and SMEs,” said Shen Minggao, Caijing chief economist. “This is likely to aggregate the tendency for China to become more dependent on heavy industry.”

Banks may tend to issue loans for large investment projects, which could restrict credit options for private enterprises.

Meanwhile, an investment-led economic stimulus may further entrench China’s old pattern of economic growth. According to the NDRC executive plan for 2009, submitted to NPC, fixed asset investment is expected to grow 20 percent, while retail consumption will likely only increase by 14 percent. This means that the consumer share of the economy, already far below desireable levels, could shrink more.

NPC Standing Committee Chairman Wu Bangguo said three indexes – the value-added services sector, service sector employment, and research and development -- did not reach previous targets. At the same time, he said, indexes for energy consumption and waste emissions have a long way to go before meeting the nation’s goals set in the most recent five-year plan.

“Our economic development pattern has not fundamentally changed, so our industrial structure is still heavy-industry oriented and our demand structure is still export- and investment-oriented,” Wu said. “Resources and the environment are under pressure. Unemployment and weak consumption levels are still outstanding issues.”