Mainland China and the Asian Financial Crisis

Asian Financial Crisis of 1997 Thai currency lost half its value in 6 months replicated in Malaysia, South Korea, Indonesia, etc. in various degrees –rapid outflow of foreign capital –plunges in stock markets –declines in exchange rates of currencies –banking crisis –problems of short-term debt repayment

Impact on mainland China Asian Financial Crisis –important impact on domestic political economy –given the new openness to world economy –was not the main force of transformation China’s domestic transition –Deng Xiaoping’s “southern tour” of 1992 –“socialist market economy” in 1993

Major events in China in 1997 Deng Xiaoping died Hong Kong returned to China 15th CCP National Congress

Political evolution Consolidation of the post-Deng regime –CCP General Secretary (’89-’02) Jiang Zemin –PRC Premier (’98-’03) Zhu Rongji acceleration of domestic transformation

Impact of the Asian Crisis Vulnerability of mainland China’s economy –relatively open economy –exports were 22% of GDP –nearly 80% direct investment from East Asia similarity between mainland China and the “crisis economies” –similar patterns of investment –similar structure of exports

Mainland China and ASEAN-4 Exports from mainland China and from Indonesia, Malaysia, Philippines, Thailand

Mainland China and ASEAN-4 both benefited from export restructuring –rapid export growth up to mid-1990s both competed in exporting labor-intensive manufactured consumer goods both competed in attracting investment from Japan and NIE’s both effectively pegged their currencies to the U.S. dollar

Mainland China and ASEAN-4 Similarity: rapidly industrializing economy outgrew the financial system mainland China’s financial system –dominated by state-owned banks –banks in turn are dominated by government personnel control directed loans to SOE’s, cronyism, and favoritism –capital markets are relatively less developed –non-performing loans may be 20% of total

Mainland China and ASEAN-4 ASEAN-4 had a more open political and economic system in regard to capital movements –capital movement into mainland China were overwhelmingly direct investment, not loans in regard to currency convertability –Chinese renminbi Yuan is convertible only on current account, not on capital account

Capital movement into mainland only 1/5 were foreign loans 4/5 were direct investment

Foreign trade regime “processing trade” in mainland China –imported inputs intended for export production –duty free and without administrative obstacles –account for 55% of mainland’s exports

Public policy choices Mainland China –more insulated economic system –more favorable economic conditions economic policy choices by post-Deng leadership –to maintain control over the aspects of economy most vulnerable to world market –to maintain a more conservative and secure position in world economy

To devalue or not to devalue? Competition in exports and in attracting direct investment all Asian neighbors devalued currencies –RMB Yuan was already over-valued –export growth was negatively affected Yuan devaluation could trigger further spiral of competitive devaluation among Asian neighbors

Asian Financial Crisis During the Asian Crisis, mainland China –suffered relatively few harmful effects opportunity to exert leadership in Asia demonstrate responsibility –refrained from devaluation of Yuan –when almost all the other Asian currencies (except HK$) were devalued –financial aid to crisis economies $4.5 billion commitment to the IMF

Domestic transformation The “bubble economy” of 1993 –Deng Xiaoping’s reform package –decentralization and marketization –financial laxity and inflationary pressure

Zhu Rongji’s policy regime Zhu Rongji –Vice-Premier ( ) –President of the People’s Bank of China ( ) –Premier ( ) Zhu Rongji’s policy regime in –macroeconomic restraint –regulatory reforms

Macroeconomic austerity conservative monetary policy banks faced harder budget constraints but also more authority –banks gained bargaining power to resist demands from especially SOE’s –banking laws re-centralized banking system to resist demands from local governments –banks were forced to be profitable

Regulatory reforms Market-oriented reforms in 1980s let the economy “grow out of the plan” new task of improving the legal and regulatory environment in 1990s –legally defined ownership categories for SOE’s privatization –abolished the “dual-track” of exchange rates –fiscal reform to re-centralize tax revenues