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Country Study: China

International Monetary Fund. Research Dept.
Published Date:
September 2004
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Thomas Rumbaugh

China’s transformation into a dynamic, private sector-led economy and its integration into the world economy have been among the most dramatic global economic developments of recent decades. This article summarizes recent IMF research on key aspects of China’s economy, as well as the main policy challenges that will need to be addressed for China to maintain sustained high growth and continued integration with the global economy.

China’s growth performance over the past two decades has been impressive, with GDP growth averaging almost 8 percent. China now ranks as the sixth-largest economy in the world (at market exchange rates). The expansion of China’s role in the world trading system has been no less remarkable, with its overall share in world trade rising from less than 1 percent in 1979 to 6 percent in 2004. Tseng and others (2003) summarize IMF research, conducted during 2000–02, on macroeconomic aspects of China’s emergence over the past 20 years, including growth dynamics, financial development, foreign direct investment (FDI), state enterprise reform, and trade and exchange rate policy. More recently, an IMF Occasional Paper, China’s Growth and Integration into the World Economy: Prospects and Challenges (Prasad and others, 2004), presents an overview of research conducted during 2003–04.

The expansion of China’s international trade has been a particularly noteworthy aspect of its rising prominence in the world economy. Rumbaugh and Blancher (2004) and Prasad and Rumbaugh (2003) analyze China’s rapidly growing trade and conclude that this process has been facilitated by trade reforms and the general opening of the economy leading to a surge in FDI and increased integration with the global trading system. Interestingly, they also find that the rapid expansion of China’s trade thus far is not unprecedented in either its scope or speed. Other Asian economies, such as Japan, Korea, and the newly industrialized economies, were able to maintain even higher export growth rates, on average, for about a 30-year period. China’s trade expansion reflects greater specialization of production within the Asian region, with China now serving as the final processing and assembly platform via which a large quantity of imports from other Asian countries go to Western countries. These changes have resulted in a shift in China’s bilateral trade balances, with its increasing trade surpluses with Western industrial countries being offset by rising trade deficits with many Asian countries. China’s imports from all trading partners, including developing countries, are growing rapidly (Yang, 2003), and it is now the third-largest importer of developing countries’ exports after the United States and the European Union.

China experienced two recent episodes of mild deflation (1998–2000 and 2001–02) despite sustained high output growth. Kumar and others (2003) discuss this experience in their study on deflation, while Feyzioğlu (2004) discusses general price developments and shows that supply-related factors have been key determinants of price dynamics in China, especially during the deflationary episodes. Some of the supply factors are transitory, including the declines in commodity prices at the beginning of each of these episodes and restraints on administrative price increases. There are also longer-term factors on the supply side, such as productivity gains from strong investment, a series of tariff reductions, state enterprise reform, and adoption of new technologies, that continue to exert significant downward pressures on prices. A large labor surplus in rural areas and excess capacity in some state enterprises are also keeping costs and prices down. More recently, particularly in 2004, commodity prices and strong growth of monetary aggregates have supported price increases.

A great deal of debate and international attention has focused on China’s exchange rate regime. China maintains a de facto fixed exchange rate regime, with the renminbi linked to the U.S. dollar within a narrow trading band. Zhongxia (2003) explores the relationship among real interest rates, the real exchange rate, and balance of payments developments and finds that significant and usually nonmonotonic interactions exist between these variables. Wang (2004) applies several techniques for estimating a currency’s “equilibrium exchange rate” to China. She examines the issue from a medium-term perspective and finds a range of estimates with the results sensitive to the underlying assumptions. This research can be interpreted, therefore, as an indication that the exchange rate may not be substantially undervalued. The analysis also shows how different sources of shocks could affect the medium-term path of the exchange rate. It concludes that the currency’s value will be inexorably linked to the ongoing structural reforms of the economy, including the further opening of domestic markets to foreign goods and services in line with World Trade Organization (WTO) commitments. The medium-term movement of the exchange rate will also depend on the nature and pace of liberalization of capital controls.

Fedelino and Singh (2004) analyze China’s public debt and implications for fiscal sustainability. With relatively low explicit government debt and a modest budget deficit, China does not face immediate concerns of fiscal sustainability. However, the government faces a number of possible future obligations associated with potential losses in the state-dominated banking system, the future funding requirements of the pension system, and rising expenditure pressures, especially for education, health, and other social programs. The authors also analyze issues related to intergovernmental fiscal relations. Center-local fiscal relations have not been effective in reducing income disparities, and the resources available to provinces, especially the poorer ones, have not kept pace with their rising expenditure mandates. A series of working papers have discussed several aspects of fiscal relations in China. Ahmad and others (2002) assess the changing nature of relations between the provinces and the central government; Ahmad, Singh, and Fortuna (2004) discuss reform options for improving intergovernmental transfers; and Ahmad, Singh, and Lockwood (2004) focus on the impact of possible tax reforms, their distribution across provinces, and possible options for compensation. Research on China’s tax system includes studies on issues related to the taxation of the financial sector (Zee and others, 2004) and on options for reforming the personal income tax (Zee and Hameed, 2004).

The fiscal implications of potential losses in the banking system underscore the urgency of financial sector reform in China. Barnett (2004) reviews bank lending practices and the dominance of state-owned banks. He also identifies the steps being taken to improve the stability of the banking system as the domestic banks prepare to face intense competition in 2006, when, under WTO accession commitments, the financial sector is opened up to foreign banks.

Many of the inefficiencies in the Chinese economy ultimately result in poor labor market outcomes. Unemployment and “underemployment” of a significant portion of the rural population remain pressing concerns as the economy adjusts to the effects of state-owned enterprise reforms and WTO accession. Brooks and Ran (2003) analyze recent labor market developments and conclude that, even with strong output growth, the unemployment problem in China is likely to worsen over the next few years because of restructuring in the rural and state enterprise sectors. Removing barriers to growth by private firms will be crucial for creating more jobs and mitigating social pressures caused by the shifting of labor from agriculture to other parts of the economy and from the state to the private sector. Further progress will also be needed in strengthening the social safety net, including the pension system, unemployment insurance, health care, and the minimum living allowance. Cheng (2003) reviews some of the economic implications of demographic trends and finds that lower fertility rates will eventually reduce the growth in labor supply over the longer term, leading to lower savings rates and lower productivity of capital.

What are the future prospects for the Chinese economy? According to recent IMF research, the rapid economic growth and trade expansion could be sustained well into the future based on China’s attractiveness as a destination for FDI, a high domestic saving rate, underlying improvements in productivity stemming from reduced barriers to both internal and external trade, and significant surplus labor. However, a number of macroeconomic and structural vulnerabilities need to be addressed for this potential to be fully realized (Feyzioğlu and Wang, 2003; and Feyzioğlu, Spatafora, and Yang, 2004). Boyreau-Debray and Wei (2004) also conclude that China can continue to grow fast if barriers to internal financial integration can be reduced.


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    AhmadEhtishamRaju J.Singh and BenjaminLockwood2004“Taxation Reforms and Changes in Revenue Assignments in China,”IMF Working Paper 04/125.

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