Wednesday, April 1, 2009

The Global Strategy of the Dragon (Part 2)

Continuing with my discussion of China’s most recent economic and investments strategies last month, we can see that this month, China has been stepping up its efforts to achieve its goal of becoming a global economic leader as well as actively participating in more global economic affairs.

In early March, amid the slowdown in foreign investments, the Chinese government announced a decision to lower its conventional heavy bureaucratic hurdles for foreign companies and allow local governments to approve certain foreign investments, shifting control away from Beijing in a move to ease foreign investment at a time when it has been declining sharply. Under the new rules, foreign businesses setting up an investment company with registered capital of less than $100 million will need to seek approval only from local commerce bureaus. The rules will create greater transparency of approval processes on a local government level and attracts more foreign investments.

Foreign investments have been vital for providing jobs and introducing new technology and management practices. However, amid the global financial crisis, China cannot solely rely on economic growth stemming from foreign investments, but rather in conjunction with domestic demand. During the annual meeting of the National People’s Congress (NPC) in China in mid-March, which delivered the 2008 government work report and 2009 economic and budget plan, China’s Premier Wen Jiabao stated that China must significantly increase investments and government expenditures to stimulate economic growth, improve people’s lives and deepen reform. Even though there are no major changes from the existing objectives and expansionary policy framework set last year, I think the Chinese government can achieve its objectives by expanding its expansionary monetary policy which aims for credit growth. With China’s new loans extended in February came in at $1.03 trillion yuan which grew strongly to 24.2% from 21.3% in January, I believe this loan growth will remain positive while slowly decreasing in the following months for two reasons.

First of all, we can expect China’s budget surplus will decrease as the government plans to use cuts and rebates to ease tax burdens for businesses and individuals. This would be the most efficient way to release consumers’ purchasing power and boost consumption, especially for the urban middle class. If the Chinese government wants to maintain an 8% revenue growth while reducing tax for businesses and individuals, the only achievable way is to provide that businesses and individuals will increase their borrowing needs.

Secondly, with the $4 trillion yuan the Chinese government’s stimulus package starting to show some positive effects, China’s manufacturing indicator – the Purchasing Manager Index – showed an ease in dropping in February and reflected some signs of stabilization and recovery. Moreover, China’s fixed-asset investment exceeded the market expectation with a growth of 26.5% from a year earlier. In my opinion, with more investment projects to start in the coming months, businesses should increase their borrowings. Therefore, with both increasing businesses and individuals expenditures, the loan growth can be maintained at a firm level while slowly decreasing throughout the year.

In order to cope with oversupply and under-demand in the Chinese economy, another significant economic reform highlighted by the premier during the NPC is the industry revitalization plans announced over the past couple of months. In addition to conventional monetary and fiscal policies that focus on boosting demand, these revitalization plans from the Chinese macroeconomic management are largely focused on reducing overcapacity through two measures to facilitate supply control: mergers and acquisitions, and increasing national strategic reserves of various commodities.

First of all, in an economic reform generated by mergers and acquisitions, big state-owned companies with close relationships with the central government will be most likely to survive in the consolidation waves while small companies, especially those that are not state-owned will be restructured and acquired by the big state-owned companies. This process enables enterprises to preserve the overall industrial profit margins. As part of the supply control, the Chinese government raised gasoline price to encourage competition among fuel suppliers and better reflect supply and demand. It also helped to protect the domestic refiners’ margins and prevent them from incurring losses, which in turn the government will have to provide more subsidies to the refiners.

Secondly, in terms of increasing national strategic reserves of commodities which I correctly predicted in my China’s strategy discussion last month, China has started to build up its sugar reserve inventory in March to 2.8 million metric tons to secure an adequate food supply. This measure not only comes at a time when commodity prices are low but also helps the government to prepare for any unforeseen disasters that would severely drop the global sugar production. The success in both measures would be able to bring supply and demand back to equilibrium.

In late March, China raised the heated debate of substituting the U.S. dollar’s dominant currency status with a new reserve currency. China’s central bank governor, Zhou Xiaochuan, called for moving toward a super-sovereign reserve currency, or one that doesn’t belong to any particular country, and expand the International Monetary Fund’s Special Drawing Rights (SDR) – a kind of synthetic currency whose value is determined by a basket of major currencies – by including the Chinese yuan. According to Zhou, moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better because it would give the reserve-currency nations more freedom to shift monetary policy and exchange rates. Even though this is a possibility, it would take a long time for this global currency reform to take effect. Moreover, though a move towards global currency reform may detract from the dominance of the U.S. dollar in the foreign exchange market, it may not necessarily be a bad thing. By losing the dominant status in the foreign exchange market, U.S. dollar would depreciate, making its exports relatively cheaper and more price-competitive than those in China. If this were to occur, it would beneficially impact the U.S.’s current trade imbalance and reduce its trade deficit. While it is still early to draw a conclusion of its technical feasibility, this currency debate will surely mark the beginning of a new era when emerging markets, especially China, are developing capabilities to lead major reforms in the international monetary system.

Paving the way for China to assume more active participation in the global economic platform, most recently, China expressed its willingness to add funding to the IMF to help developing countries hurt by the financial crisis and also to buy bonds issued by the IMF. However, with sufficient liquidity on China’s hand thus more leverage in negotiating, China wants to have more voting power in IMF in exchange for the new funding. If these objectives are achieved, it will provide more influence to China in the IMF and global finance in the coming decades.

Although China’s aggressive policy stimulus remains absolutely crucial in terms of China’s economic outlook, its strength of recovery still hinges on that in the developed economies. If the developed economies fail to rebound in the second half of this year, it will hinder China’s economic recovery and will require more policy stimulus on top of the existing package in order to sustain a rebound. But with China's stronger influence in the overall structure of the new global financial system, surely China’s international economic and finance position will gain more credibility and exert more impact over this economic downturn and in the future.

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