CHINA MONETARY POLICY REPORT

 

  

Monetary Policy Analysis Group of

the People's Bank of China
Executive Summary

 

Affected by the war on Iraq and the outbreak of SARS epidemic, the world economy slowed down in the first half of 2003 and performed weaker than expected. Major economies recorded moderate growth and the turbulence in international financial markets intensified. China made strenuous efforts in the prevention and control of the SARS epidemic on one hand and in fostering economic development on the other, which enabled the economy to have maintained its sound growth momentum. In the first half of the year, GDP exceeded RMB5 trillion yuan, up 8.2 percent over the same period of the previous year. Consume prices continued to remain at subdued levels.

 

The People's Bank of China (PBC) continued to implement the sound monetary policy, proactively took various measures of financial services to contain the SARS impact, and made use of various monetary policy instruments to maintain high growth of credit, creating a favorable environment to produce generally stable financial performance.

 

Money supply grew rapidly. Broad money M2 grew by 20.8 percent over the same period of 2002 to RMB20.5 trillion yuan, M2 growth was 12 percentage points higher than the sum of GDP growth and CPI increase, the highest level since 1998. Loans by financial institutions increased at a high rate with total loans in both renminbi and foreign currencies increased by RMB1.9 trillion yuan to RMB15.9 trillion yuan. The reserve ratio of financial institutions averaged 3.88 percent, down 2.59 percentage points from the end of 2002. The official foreign exchange reserves reached US$346.5 billion, representing an increase of US$60.1 billion over the end of 2002. The exchange rate of renminbi remained stable, being at RMB8.2774 yuan against one US dollar.

 

Based on comprehensive analysis, the negative impact of the SARS outbreak on the Chinese economic growth for the whole year appears to be limited and the economy will maintain its sound growth momentum in the second half. However, the better than expected economic situation does not warrant a sense of complacency and more importance needs to be attached to studying and resolving acute problems arising in the course of economic and social development. First, in-depth analysis should be conducted and great attention be paid to examine the reasons behind the current rapid growth of loan and the risks that might incur. Second, vigilance should be kept to irrational investment and duplicated construction in some regions and sectors that might aggravate economic structural imbalance. Third, great efforts should be made to explore ways to create more jobs and increase farmer's income. Fourth, credit access for small and medium sized enterprises (SMEs) should be continuously expanded to support the development of the SMEs. Fifth, the impact of global economic development and other significant unexpected events on the Chinese economy should be closely monitored so as to work out responsive measures in a timely manner.

 

Monetary policy stance in the second half is as follows: First, continue to implement the sound monetary policy and maintain steady growth of credit; second, continue to improve financial service aiming at supporting job creation and farmer's income rise; third, prevent duplicated construction and guard against financial risks; fourth, maintain basic stability of RMB deposit and loan interest rates and steadily push forward market-based interest rate reform; fifth, maintain basic stability of RMB exchange rate and further improve the RMB exchange rate regime; sixth, strengthen construction of credit information system and speed up the establishment of the nationwide enterprise and individual credit reporting arrangement.

 

Part One     Monetary and Credit Performance

 

In the first half of 2003, China made strenuous efforts in the prevention and control of the SARS epidemic on one hand and in fostering economic development on the other, which enabled the economy to have maintained its sound growth momentum. The People's Bank of China (PBC) continued to implement the sound monetary policy and proactively took various measures of financial services to contain the SARS impact, creating a favorable environment to produce generally stable financial performance.

 

I. Rapid growth of money supply

 

In the first half of the year, broad money M2 grew by 20.8 percent over the same period of 2002 to RMB20.5 trillion yuan. Narrow money M1 grew by 20.2 percent to RMB7.6 trillion yuan. Cash in circulation M0 grew by 12.3 percent to RMB1.7 trillion yuan. Net cash withdrawal reached RMB32.1 billion yuan, 27 billion less than the same period of 2002. The growth of M1 and M2 represented an acceleration of 6.1 and 7.4 percentage points respectively, and M2 growth was 12 percentage points higher than the sum of GDP growth and CPI increase, the highest level since 1998.

 

Figure 1      Movement of the Differential between M2 Growth and the Sum

                    of GDP Growth and CPI Increase between 1998 and June, 2003

 

 

Source: PBC Quarterly Statistical Bulletin

 

 

 

II. Large increase of loans by financial institutions

 

In the first six months, total loans in both renminbi and foreign currencies by financial institutions (including foreign-funded ones) increased by RMB1.9 trillion yuan or 22.9 percent to RMB15.9 trillion yuan, an acceleration of RMB1 trillion yuan over the same period of last year. In particular, renminbi loans grew by RMB1.8 trillion yuan or 23.1 percent, representing an acceleration of RMB951.0 billion yuan or 10.9 percentage points, while foreign currency loans grew by US$14.8 billion or 19.5 percent, representing an acceleration of US$10.1 billion.

 

In terms of the sources of loan increase, loans in renminbi and foreign currencies by wholly state-owned commercial banks increased by RMB1.1 trillion yuan, with an acceleration of RMB650.0 billion yuan, accounting for 62.8 percent of the total by all financial institutions. Those by joint-stock commercial banks grew by RMB410.7 billion yuan, representing an acceleration of RMB165.5 billion yuan. Loans by policy banks increased by RMB74.1 billion yuan, representing an acceleration of RMB31.3 billion yuan. Loans by rural credit cooperatives (RCCs) grew by RMB221.9 billion yuan, accelerating by RMB63.0 billion yuan. Wholly state-owned commercial banks constituted the main source of loan increase in the first half of this year.

 

Table 1 Trend of Growth and Growth Rate of the Renminbi Loans by Financial Institutions since 1998

 

Year	Growth of Loans			Growth Rate of Loans （%）	GDP Growth Rate（%）	CPI （%）	Differential between loan growth rate and the sum of GDP growth rate and the CPI
	First Half of the Year	The Whole Year	Ratio of the First Half-year Figure to the Total （%）
1998	3773	11491	32.83	15.5	7.8	-0.8	8.5
1999	4232	10846	39.02	12.5	7.1	-1.4	6.8
2000	6204	13347	46.48	13.4	8.0	0.4	5.0
2001	7152	12913	55.39	11.6	7.5	0.7	3.4
2002	8322	18488	45.01	15.1	8.0	-0.8	7.9
1998-2002 Average	5937	13417	43.75	13.6	7.7	-0.4	6.3
The First Half of 2003	17810	-	-	23.1	8.2	0.6	14.3

 

Note: Loans in the first half of 2003 include those of foreign-funded financial institutions.

Sources: China Statistical Summary 2003, Sources and Uses of Credit Funds of Financial Institutes

 

 

In terms of the destination flow of loans, the new renminbi loans in the first half of the year mainly went to five areas. First, discount loans for commercial bills grew by RMB339.3 billion yuan, representing an acceleration of RMB257.9 billion yuan over the same period of 2002. Second, loans for infrastructure and technological innovation rose by RMB298.6 billion yuan, an acceleration of RMB168.0 billion yuan. Third, consumer loans increased by RMB245.9 billion yuan, accelerating by RMB107.0 billion yuan. In particular, individual housing loans grew by RMB152.1 billion yuan, and auto financing loans increased by RMB48.3 billion yuan, accelerating by RMB47.8 billion yuan and RMB20.3 billion yuan respectively. Fourth, agricultural loans increased by RMB143.1 billion yuan, accelerating by RMB28.5 billion yuan. Fifth, loans for foreign-funded and privately-owned enterprises, self-employed workers as well as village and township enterprises increased by RMB101.7 billion yuan, accelerating by RMB81.9 billion yuan. The loan increase of these five categories totaled RMB1.1286 trillion yuan, or an acceleration of RMB643.3 billion yuan, accounting for 63 percent of the increase and 68 percent of the acceleration of loans by all financial institutions respectively.

 

 

Box 1             Analysis on Accelerated Growth of Credit   Since the latter half of the previous year, growth of credit   accelerated. From 1998 to 2002, the annual new loans in renminbi by financial institutions reached RMB1.15 trillion yuan, RMB1.08 trillion yuan, RMB1.33 trillion yuan, RMB1.29 trillion yuan and RMB1.85 trillion yuan respectively while those for the first half of this year chalked RMB1.8 trillion yuan, close to those for the whole year 2002. The growth rate of the aggregate money supply M2 arrived at 15.3%, 14.7%, 12.3%, 14.4% and 16.8% respectively while that in the first half of this year reached 20.8%. The differential between M2 growth and the sum of GDP growth and CPI increase in the same period [growth rate of M2 – (growth rate of GDP+CPI)] was 8.3 percentage points, 9.0 percentage points, 3.9 percentage points, 6.2 percentage points and 9.6 percentage points respectively while that in the first half of this year increased to 12 percentage points. The ratio of M2/GDP was 1.33, 1.46, 1.51, 1.65 and 1.81 respectively while that for 2003 is forecast to climb to 2.0.   The main reasons for the accelerated growth of credit were as follows. First, the Chinese economy has forged a good growth momentum, with industrial production accelerated and corporate profits gained immensely, hence generating stronger effective demand for loans. The industrial added value by the statistically large enterprises grew by 12.6 percent in 2002, representing an acceleration of 2.7 percentage points over the previous year while it grew by 16.2 percent in the first half of this year. The total net profits realized by the industrial enterprises in 2002 registered RMB562.04 billion yuan, up year-on-year 20.6 percent, representing an acceleration of 12.5 percentage points over the previous year while those realized in the first half of this year totaled RMB363.8 billion yuan, up as much as 56.7 percent over the same period of last year. In the meantime, direct financing by enterprises shrank continuously while financing through banks expanded, and hence loans soared. Second, fixed assets investment, in particular that of real estate development maintained high growth. In the first half of this year, fixed assets investment amounted to RMB1.9 trillion yuan, up 31 percent over the same period of the previous year and that of real estate development RMB381.7 billion yuan, up 34 percent. Meanwhile, spurred by strong consumption of such items as housing and autos, consumer loans rocketed. Consumer loans in 2002 rose by RMB369.4 billion yuan or 34 percent, accelerating by RMB93.8 billion yuan over the previous year. Those in the first half of this year increased by RMB 245.9 billion yuan or 77 percent, representing an acceleration of RMB107.0 billion yuan. Third, the operation mechanism of commercial banks was transformed. Wholly-state-owned commercial banks strengthened reform on internal operational mechanism, promoted loans marketing, expanded limits of authorization and credit approval by the grass-roots branches, lowered the interest rates for internal funds deposited in the head offices, and consequently loans granting was propelled. Besides, commercial banks strengthened review mechanism one after another. As it is stipulated that 1 percent of the loans outstanding at the year-end be appropriated for loan loss provisioning and the current gross spread between loans and deposits is 2 percent approximately, commercial banks could earn a profit of 1 percent if they granted loans in the first half of the year and they would incur losses let alone make profits if they did so in the latter half. Commercial banks in such a case would make efforts to grant loans earlier in the year to realize profits. Furthermore, some commercial banks, under the pressure of lowering the ratio of non-performing loans (NPLs), had the motivation of diluting NPLs with new loans. Fourth, although the PBC was taken the "Sterilization" measures, base money kept growing as more funds were injected to purchase foreign exchange in the market and hence money supply expanded.   The significant growth of credit was a result of combined effects of sound economic growth and the policy of expanding domestic demand taken in recent years. It was conducive to supporting the sustained and steady economic growth and thus was generally viewed as a normal development. However, since credit culture is underdeveloped in China and the mechanism of internal control in banks still need improvement, a protracted high growth of credit would likely foster duplicated construction and stockpiling of inventory, and subsequently lead to rise of NPLs and financial risks. Therefore, great importance should be attached to potential risks to result from high growth of credit, so as to prevent and resolve risks inherent in the economic and financial operations.

 

III. Considerable growth of deposits

 

In the first half of this year, total deposits in renminbi and foreign currencies of financial institutions increased by RMB2.3 trillion yuan or 21.9 percent over 2002 to RMB20.7 trillion yuan, representing an acceleration of RMB858.4 billion yuan over the same period of 2002. In particular, renminbi deposits increased by RMB2.34 trillion yuan or 23.3 percent, representing an acceleration of RMB893.9 billion yuan over the same period of the previous year. Foreign currency deposits rose by US$330 million or 4.4 percent, decelerating by US$4.28 billion over the same period of last year.

 

Corporate deposits in renminbi of financial institutions increased by RMB674.4 billion yuan over 2002 to RMB6.7 trillion yuan, an acceleration of RMB372.8 billion yuan over the same period of the previous year. Household savings deposits grew by RMB1 trillion yuan to RMB9.8 trillion yuan, representing an acceleration of RMB265.5 billion yuan.

 

Figure 2    Movements of Growth of Corporate Deposits and Household

Savings Deposits in Renminbi of Financial Institutions since 1998

 

 
 

Source: Sources and Uses of Credit Funds of Financial Institutions

 

IV. Decrease of the reserve ratio of financial institutions

 

At the end of June, the balance of base money of the central bank reached RMB4.3 trillion yuan, representing an increase of 6.7 percent from a year earlier, a deceleration of 5.2 percentage points from the growth rate recorded for 2002. The reserve ratio of financial institutions averaged 3.88 percent, down 2.59 percentage points from the end of 2002. The ratio was 3.65 percent for wholly state-owned commercial banks, 4.06 percent for joint-stock commercial banks and 4.08 percent for rural credit cooperatives (RCCs), indicating adequate liquidity of financial institutions.

 

V. Broad stability of interest rates

 

In the first half of this year, the official interest rates for deposits and loans prescribed by the PBC remained stable. The interest rates on loans charged by commercial banks were floating reasonably within the range stipulated by the PBC. A survey by the PBC on 14 national commercial banks showed that 57 percent of loans were charged interest rates lower than or equivalent to the benchmark rates while 43 percent of loans were charged interest rates higher than the benchmark rates. The interest rates on large-amount deposits of commercial banks kept going down. Those with a maturity of 61 months saw their interest rates mainly in the range of 3.1 percent to 3.3 percent in the first quarter and in the range of 2.9 percent to 3.2 percent in the second quarter, decreasing by 0.25 percentage points and 0.7 percentage points respectively over the corresponding periods of the previous year.

 

Table 2     Average Interest Rates on Large Amount US Dollar

Deposits and Loans from January to June of 2003

 

 

Source: PBC

 

Interest rates for large-amount foreign currency deposits and loans all took a falling trend. In June, among the large-amount foreign currency deposits in commercial banks, the weighted average interest rate of one-year US dollar deposits was 0.8341 percent, down 0.2191 percentage points from that in January. The weighted average fixed interest rate of one-year US dollar loans was 2.5959 percent, down 0.4956 percentage points from that in January while the weighted average floating interest rate was 1.9538 percent, down 0.2823 percentage points from that in January (Table 2).

 

VI. Continuing stability of renminbi exchange rate

 

In the first half of the year, the balance of payments position was kept strong. At the end of June, the official foreign exchange reserves reached US$346.5 billion, representing an increase of US$60.1 billion over the end of 2002. The exchange rate of renminbi remained stable, being at RMB8.2774 yuan against one US dollar.

 

 

 

Part Two    Monetary Policy Conduct

 

I. Flexible open market operations and steady growth of base money

 

In the first half of the year, the PBC withdrew an accumulated RMB277.8 billion yuan of base money through open market operations and released an accumulated RMB387.6 billion yuan through foreign exchange operations, resulting in a net release of RMB109.8 billion yuan in base money. Through open market operations, the PBC managed to maintain steady growth of base money and stable money market rates. Base money growth moderated to 6.7 percent in June from 15.04 percent in January. At the end of June, the 7-day repurchase rate stayed around 2.25 percent.

 

In Q2, the PBC started issuing central bank bills to adjust base money and liquidity and to guide the money market rates. On 10 issue days between April 22 and June 30, the PBC offered RMB195 billion yuan in 17 issues through price bidding. Issues of 3-, 6- and 12-month maturity were RMB90 billion yuan, RMB75 billion yuan and RMB30 billion yuan respectively. Central bank bills represented both an innovative tool in open market operations and a practical choice in monetary policy conduct.

 

 

II. Credit and financial services during SARS outbreak

 

In the face of the abrupt outbreak of SARS epidemic, the PBC issued "Urgent Circular on Improving Financial Services during SARS Outbreak" and "The PBC Opinions on Improving Credit Service to Address the Impact of SARS" on April 28 and May 19 respectively. The main contents of these documents were the following. First, the PBC branches and the commercial financial institutions should seek timely information on the demands of financial services and assure the normal running of business and financial system operation. Second, the currency distribution fund should be well managed to ensure payment and settlement system run smoothly and market order. Third, appropriate growth in bank credit should be assured so that finance can play its role in supporting economic growth. Sufficient credits for SARS prevention purposes should be assured. Fourth, credit will be properly more supplied to support industries and areas most severely afflicted by SARS. Consistent with the government practice to provide temporary interest subsidies to civil aviation, tourism and retail business, working capital loans will be provided to enterprise undergoing temporary contraction or liquidity difficulties. Fifth, consumption and other growth engine for the economy should be actively nurtured. For instance, support should be given to enterprises involved in the development, production and sales of health and hygiene products. Sixth, agricultural loans should be well administrated and funds should be prepared to meet credit demand of upcoming summer harvest and the seeding season. These measures proved important in maintaining the stable running of credit service during the SARS outbreak.

 

III. Coordinated interest rate policy for RMB and foreign currency and steady Development of Market-based Interest Rate Reform

 

In the first half of 2003, while maintaining the stable lending rate of RMB, the PBC promoted market-based interest rate reform and conducted careful studies on the programme to widen the floating range of RMB lending rates according to the overall objective of the interest rate reform.

 

On July 2^nd, while lowering the small-value foreign currency deposit rates, the PBC streamlined its administration of interest rates for small deposits in pound sterling, Swiss franc, Canadian dollar, leaving them to the discretion of the commercial banks. By then, the number of foreign currencies with their deposit rates decided and announced by the PBC reduced from 7 to 4. The remaining four currencies are, the US dollar, the euro, Hong Kong dollar and Japanese yen.

 

IV. Improved credit policy for real estate sector development

 

Currently, 60 percent of the funds invested in the real estate market are financed through the banking system. Real estate loans accounted for 17.8 percent of the total credit of the commercial banks. In order to defuse risks associated with the rapid expansion of the real estate loans, after wide-range consultation, the PBC issued "The Circular on Further Strengthening Management of Real Estate Credit" on June 5, which required the commercial banks to strengthen their credit management in all aspects from land acquisition to development, construction and sales. While regulating the credit flow to the real estate sector, the PBC will coordinate with other relevant agencies to develop more financing channels for the real estate developers, with equity financing in particular.

 

V. Support to financial reform in the rural area

 

According to the "Pilot Programme for Deepening Reform of the Rural Credit Cooperatives" approved by the State Council, the PBC, after careful studies and making sure that moral hazards are effectively deterred, has decided to provide financial support to the credit cooperatives in regions where the pilot project is to carry out to alleviate their historical legacy problems and facilitate smooth operation of the reform programme. Meanwhile, micro loans were further expanded to support rural economic development and increase the rural household income.

 

VI. Close monitor of major currency exchange rate movements and efforts to maintain RMB stable

 

Against the backdrop of large movements in the exchange rates of the major currencies, the PBC intensified its monitor of the international financial markets. Timely analysis was made on the currency movements and its impact on the RMB. In addressing the strong growth of base money resulted from foreign exchange sterilized operations, central bank bills were issued and open market operations intensified to withdraw base money and maintain RMB exchange rate stable. Meanwhile, a number of policies were made to facilitate use of foreign exchange by enterprise and individuals, improve efficiency in the use of foreign exchanges, encourage enterprise to invest abroad and increase market forces in the formation of exchange rate.

 

 

 

 

Part Three      Financial Market Performance

 

I . Active inter-bank market

 

The first half of 2003 witnessed active RMB transactions in the inter-bank market, with accumulated turnover of the inter-bank borrowings and bond transactions totaling RMB7150 billion yuan, a growth of RMB2050 billion yuan or 40.3 percent over of the first half of 2002 (In the second quarter alone, the accumulated turnover recorded RMB3987.6 billion yuan, RMB825.3 billion yuan more than that of the first quarter). In particular, the turnover of inter-bank borrowings increased by RMB608.3 billion yuan or 1.3 times to RMB1090 billion yuan, the turnover of inter-bank bond outright transactions increased by RMB761.5 billion yuan or 3 times to RMB1010 billion yuan, and the turnover of bond repurchase grew by RMB682.4 billion yuan or 15.6 percent to RMB5040 billion yuan.

Figure 3  Transaction Volumes at the Inter-bank Market

 

 

Source: PBC China Financial Market Monthly Statistical Bulletin.

 

With regard to flow of funds in inter-bank market, the state-owned commercial banks as a whole remained to be the only net providers of funds, and the largest recipients of funds remained to be commercial banks (including joint-stock commercial banks and city commercial banks) and other financial institutions (including securities firms, fund management companies, associations of rural credit cooperatives, policy banks, finance companies, trust and investment companies). With respect to the weight of different fund recipients in net borrowings, the share of other commercial banks and securities firms climbed in the first half of 2003 at a faster pace than a year ago, while the share of insurance companies and other financial institutions dropped markedly. (Table 3)

 

Table 3    Fund flow of financial institutions

                                                                                                RMB 100 million yuan

	Net borrowings	Yea-on-year growth in amount	Year-on-year growth in percentage (%)
State-owned commercial banks	-25478 (1)	-3579 (2)	16.3
Other commercial banks	12965	4070	45.8
Other financial institutions	12210	-682	-42.8
Securities firms and fund management companies	4922	1663	51.0
Insurance firms	306	-1526	-83.3
Others	6982	-819	-10.5

Note: (1) "-" means net outflow; (2) "-" means an accelerated growth of net outflow on a year-on-year basis.

Source: PBC China Financial Market Monthly Statistical Bulletin.

 

In the first half of 2003, the monthly-weighted average interest rates in inter-bank borrowing market and bond repurchase market declined in a row from 2.16 percent and 2.28 percent in January to 1.98 percent and 1.97 percent in April respectively. These two interest rates then rebound in May by 0.04 and 0.07 percentage points from April, and the rise continued in June to 2.11 percent and 2.17 percent respectively.

 

Figure 4  Movement of Monthly Weighted Average

Money Market Interest Rates

Source: PBC China Financial Market Monthly Statistical Bulletin

 

II.  Smooth issuance of bonds

 

The first half of 2003 saw a total of RMB314 billion yuan worth of government securities issued, which marked an increase of RMB54 billlion yuan or 20.8 percent over the same period of 2002 (In second quarter alone, RMB219 billion yuan worth of government securities were issued, 1.3 times larger than that of the first quarter). Among the new issue, RMB140 billion yuan were bearer's treasury bonds, up 130 percent from the first half of 2002 and RMB174 billion yuan were book-entry treasury bonds, down 13 percent or RMB26 billion yuan. In addition, policy financial bonds issued in the first half of this year totaled RMB138 billion yuan, RMB32.5 billion yuan or 30.8 percent more than the same period of a year earlier (In second quarter alone, RMB98 billion yuan were issued, 1.5 times of that issued in the first quarter). Also in the first six months of 2003, total of RMB6.5 billion yuan worth of corporate bonds were issued, RMB1 billion yuan or 13.3 percent less than that issued in the same period of 2002 (There was no new issue of corporate bonds in second quarter).

 

Box 4        China's Bond Market   1.      The evolution of China's bond market   Prior to 1997, China's bond market mainly comprised exchange-based bond transactions and over-the-counter (OTC) transactions of bearer's treasury bonds at banks. Starting in June 1997, commercial banks retreated from the bond exchanges and began to conduct the outright and repurchase transactions of the securities at the custody of China Government Securities Depository Trust & Clearing Co. (CGSDTC). Since then, China's bond market has been reshaped to consist of inter-bank market, exchange market, and an OTC market.   Inter-bank bond market   The inter-bank bond market is also an OTC market where the institutional investors trade bonds on a wholesale basis. A majority of book-entry treasury bonds and all policy financial bonds are issued and traded on this market. The trading in inter-bank market is quote-driven, and executed case by case at negotiated price. As of end-June, 2003, the outstanding balance of bonds traded in inter-bank market was RMB2740 billion yuan, in which RMB1480 billion yuan were treasury bonds, RMB1030 billion yuan were policy financial bonds, and RMB240 billion yuan were central bank bills.   Bond exchange market   The exchange market is the marketplace where both institutional and individual investors trade bonds. The trading at exchanges is order-driven, and executed at matched price. As of end-June, 2003, the outstanding balance of bonds traded at exchanges was RMB363.5 billion yuan, in which RMB330.8 billion yuan were treasury bonds, and RMB32.7 billion yuan were corporate bonds.   OTC market   The OTC market comprises two segments. One is for the Ministry of Finance to issue bearer's treasury bonds to individuals and enterprises. The other is both for the Ministry of Finance to issue and for individuals and enterprises to trade book-entry treasury bonds.   2.      Issues to be addressed in developing China's bond market   China's reforms and open-door policies have contributed to an increasingly optimized financial structure and diversified financial products. However, the structure of financing in China is still unbalanced, in which indirect financing primarily through banking system still played a dominant role while the share of direct financing was excessively small. Thus, the heavy reliance of Chinese enterprises on bank credit has become a crucial issue to be addressed in further developing its financial industry. The development of bond market is not only an important component of financial structural reform, but also conducive to improving central bank's role in macro economic management and promoting market-based interest rate reform.   For the time being, several issues need to be addressed in developing China's bond market.   First, inadequate bond supply and unbalanced market development. China's bond market in general lags behind those of the developed economies. At end-2002, the outstanding balance of bonds traded in China's bond market including treasury bonds (bearer's bonds included), policy financial bonds and corporate bonds accounted for 34.22 percent of China's GDP, while the comparable figure in major market economies was around 100 percent. In addition, China's bond market supply is severely inadequate, and the overall market structure is irrational in a way that the treasury bonds and policy financial bonds occupy a dominant proportion and corporate bonds take an excessively small share. Furthermore, the composition of bonds is obviously biased towards long-term bonds. Second, insufficient market liquidity. This is caused not only by shortage of bond supply, but also by over-simplified trading options, the absence of market-makers, brokers and other intermediary players necessary for a competitive market, and poor market transparency. Third, underdevelopment of rating system in the bond market. At present, China's bond market still lacks an independent, fair and authoritative rating system, which can regulate information disclosure of bond issuers on an on-going basis. Fourth, relatively weak infrastructure of bond market. The bond trading, depository and settlement system needs to be upgraded in consistence with the evolution of bond market.   3.      Outlook of China's bond market   The objective of China's bond market development is to establish an integrated market nationwide accessible to all financial institutions, corporate entities and individual investors. This market comprises different functional segments in which wholesale-based OTC market serves as the key pillar while retail-based exchange market as the complement. The inter-bank bond market and exchange market, though different in functions, are intertwined because of the overlapping of market players. Such link needs to be further strengthened so that those rule-compliant market participants will have the discretion to choose the places and options of trading, and funds will be able to flow freely between different market segments.   In particular, following effort will be made to promote development of China's bond market:   First, bond supply will be increased. During the process of commercial banking reforms, financial engineering and modern information techniques will be employed to realize the securitization of credit assets. Commercial banks, while restructuring their liability portfolio, will be allowed to issue financial bonds and CDs. Meanwhile, measures will be taken to expand the market for corporate and project bonds, to diversify the maturity of bonds and to ensure a balanced and coordinated development of bond markets of different products.   Second, market conditions will be improved to enhance liquidity of the secondary market. Effort will be made to further develop the market-maker system, improve bond market liquidity, boost bond brokerage business and promptly introduce bond derivatives.   Third, bond rating system will be created. In face of the needs of non-governmental institutions, especially commercial entities to issue bonds, it is crucial to put into place a regulated, transparent and fair credit rating system.   Fourth, bond depository and settlement system will be upgraded. Prompt effort will be made to realize DVP settlement of bond transactions so as to avoid the settlement risks. Advanced international experience will be learnt in an attempt to further develop the electronic trading system by applying anonymous price bidding and deal striking techniques, and develop the brokerage functions of electronic trading system. The bond trading and settlement systems will be connected to enhance the trading efficiency of bond market.

 

III.                Continued expansion of bills market

 

In the first half of 2003, the accumulated amount of bank acceptance (BA) issued was RMB1247.4 billion yuan, marking a growth of RMB551.6 billion yuan or 79.3 percent over the same period of 2002, and the accumulated amount of bills discount and rediscount totaled RMB1950 billion yuan, a growth of RMB 1050 billion yuan or 120 percent. At end-June, 2003, the outstanding balances of BA issued and discount were RMB1074.1 billion yuan and RMB821.6 billion yuan respectively, rising RMB507.2 billion yuan and RMB417 billion yuan or by 89.5 percent and 100 percent over those recorded at end-June, 2002. The rapid expansion of commercial bills market has contributed to a more efficient allocation of financial resources, and helped alleviate the financing difficulty faced by small and medium-sized enterprises.

 

The expansion of bills market is attributed to the following factors. First, the accelerated economic growth and robust business operations of enterprises have boosted the demand for funds, especially short-term capital. Second, motivated by lower cost of bills financing as compared to that of bank credit, enterprises are actively engaged in bills issue and discount. In comparison, interest rate charged for 6-month loans is currently standing at 5.04 percent, while the discount rate at its peak level was merely 3.6 percent in the first half of 2003. Third, because of its advantages like profitability, relatively high turnover and security, bills transaction has become an increasingly popular business for commercial banks who are taking various measures to expand bills business. However, in spite of rapid expansion of bills market, attention should be paid to ensure the legitimacy of bills financing and to guard against the potential risks. On June 30, 2003, China Bills Network (CBN) was officially put into operation, which provides price quotes, business inquiries and on-line business negotiations on bills discount and repurchase. The introduction of CBN will contribute to an all-around development of a healthy bills market.

 

IV. Steady operation of stock market

 

The first half of 2003 witnessed a more active stock market in comparison to the same period of 2002. The combined turnover of Shanghai and Shenzhen stock exchanges in the first six months totalled RMB1800 billion yuan, increasing by RMB118.3 billion yuan over the first half of 2002 (In the second quarter alone, the combined turnover was RMB1100 billion yuan, up RMB468 billion yuan on the first quarter), while the daily turnover averaged at RMB15.81 billion yuan, up RMB630 million yuan or 4.2 percent. The accumulated turnover of A share market alone swelled by RMB136.7 billion yuan to RMB1800 billion yuan, while its daily average turnover rose by RMB820 million yuan or 5.6 percent to RMB15.5 billion yuan.

 

In the first five months of this year, both the Shanghai and Shenzhen stock markets edged upward in fluctuations. At end-May, the Shanghai Composite Index closed at 1576, up 218 points or 16.1 percent from end-2002, while the Shenzhen Composite Index closed at 441, up 52 points or13.4 percent. In June, both stock markets slid downward. At end-June, the Shanghai Composite Index closed at 1486, down 5.7 percent from the previous month, while the Shenzhen Composite Index closed at 407, down 7.7 percent.

 

Figure 5 Closing Index of the Stock Market at Month End

 

Source: PBC China Financial Market Monthly Statistical Bulletin

 

In the first half of 2003, the corporate sector raised an aggregate of RMB35 billion yuan in stock market, down RMB6.7 billion yuan or 16.1 percent from the first half of 2002 (In second quarter alone, an aggregate of RMB14.5 billion yuan were raised, down RMB6 billion yuan from the first quarter). The total amount raised in the A share market (including IPO, and rights and additional share issues) was RMB21.2 billion yuan, down RMB18.7 billion yuan or 46.8 percent, the funds raised in H share market amounted to US$466 million, up US$412 million, and the convertible bonds issued totaled RMB9.9 billion yuan, up RMB7.6 billion yuan.

 

In the first six months of 2003, funds newly raised by the non-financial sector (including households, enterprises and government agencies) in China in the form of bank credit, stocks (negotiable stock only), government securities and corporate bonds aggregated RMB2130 billion yuan (in both local and foreign currencies), up RMB1050 billion yuan or 98.2 percent from the same period of a year earlier. The proportion of financing through bank credit, government securities, corporate bonds and stocks stood respectively at 89.5 percent, 8.6 percent, 0.3 percent and 1.6 percent. In comparison to that of the first half of 2002, the proportion of capital raised through bank credit went up by 8.8 percentage points, while financing through issues of government securities, corporate bonds and stocks dropped respectively by 6.1, 0.4 and 2.3 percentage points. The sharp fall of the share of direct financing deserves due attention.

 

Table 4    Financing in Domestic Financial Market

	Annual newly increased financing				Share (%)
	First six months of 2003	First six months of 2002	2002	2001	First six months of 2003	First six months of 2002	2002	2001
Total	21272	10734	23976	16555	100.0	100.0	100.0	100.0
Bank loans	19033	8667	19228	12558	89.5	80.7	80.2	75.9
Government bonds	1824	1575	3461	2598	8.6	14.7	14.4	15.7
Corporate bonds	65	75	325	147	0.3	0.7	1.4	0.9
Stocks	350	417	962	1252	1.6	3.9	4.0	7.6

Source: Statistics Department, PBC.

 

V . Rapid growth of insurance market

 

The insurance market in China has been growing rapidly over recent years. First, the number of insurance companies keeps growing. As of end-2002, 58 insurance companies have been established in China, with aggregate assets totaling RMB649.4 billion yuan, a growth of 41.5 percent over 2001. The insurance sector has maintained the rapid growth momentum in 2003, with the aggregate assets reaching RMB780 billion yuan at the end of June, 2003. Second, insurance premium income continued to rise. Between 1980 and 2001, insurance premium income of China's insurance sector grew at an average annual rate of 32 percent, reaching RMB305.42 billion yuan at end-2002. Premium income of the first half of this year totaled RMB212.61 billion yuan, increasing by 32 percent over the same period of 2002. Meanwhile, the insurance sector in China is playing an increasingly important role in compensating for economic losses. The accumulated insurance claim payments recorded RMB70.673 billion yuan for 2002, and amounted to RMB26.7 billion yuan for the first half of 2003, representing a growth of RMB5 billion yuan from the corresponding period of 2002. Third, both the insurance depth (insurance premium income as a percentage of GDP) and the insurance density (per capita premium income) grow steadily. The insurance depth and density in China have been steadily expanding from 0.1 percent and RMB0.47 yuan in 1980 to 2.98 percent and RMB237.6 yuan in 2002. Fourth, insurance of persons develops faster than property insurance. In 2002, the premium income of insurance of persons reached RMB227.46 billion yuan, accounting for 74.5 percent of the total insurance premium, while the premium income of property insurance amounted to RMB77.85 billion yuan, weighting 25.5 percent of the total. In the first half of 2003, premium income generated by insurance of persons recorded RMB165.26 billion yuan, marking a growth of 39.3 percent and a dominant share of 77.7 percent of the total, while the property insurance premium income grew by 11.8 percent to RMB47.35 billion yuan, accounting for 22.3 percent of the total. With respect to insurance of persons, life insurance generated about 90 percent of the premium income. Among life insurance, the non-traditional investment products have been developing much faster than the traditional insuring products. Take 2002 for example, investment products generated 54 percent of the total life insurance premium income.

 

As a consequence of the rapid development of insurance industry, disposable funds of insurance companies are growing steadily. At end-March, 2003, the outstanding balance of disposable funds reached RMB629.2 billion yuan, of which bank deposits, and investment in government bonds, securities investment funds, financial bonds, corporate bonds and other products accounted for 50.39, 18.1 percent, 5.12 percent, 9.12 percent, 3.44 percent, and 13.83 percent respectively. A crucial task faced by China's insurance sector is to expand the investment channels and enhance the efficiency of investment with the help of supportive policy measures and by improving the fund operation capability.

 

VI. Notable growth of Inter-bank foreign exchange transactions

 

Due to the expanding trade surplus, growing spread of US dollar interest rates at home and abroad, and fluctuations of interest rate spread of local and foreign currencies, inter-bank foreign exchange transactions grew notably in the first half of 2003. As a result, the accumulated turnover of inter-bank foreign exchange market increased by US$20.6 billion to USD$59.1 billion, and the average daily turnover increased by 50.8 percent to USD$484 million. In particular, the turnover of transactions in US dollar was USD$57.7 billion with the daily turnover averaging at USD$473 million, up 50.6 percent.

 

 

 

Part Four      Analysis of Macroeconomic Developments

 

I. Global economic and financial developments

 

Affected by the war on Iraq and the outbreak of SARS epidemic, the world economy slowed down in the first half of the year and performed weaker than expected. International organizations revised downward their forecasts of the global economic growth successively. In April the IMF lowered its forecast by 0.5 percentage points to 3.2 percent from that projected last September, slightly higher than the real growth recorded in 2002.

 

Major economies recorded moderate growth. The US GDP grew by 1.4 percent and 2.4 percent in the first and second quarters respectively with signs of picking up, but the unemployment rate jumped to 6.4 percent in June, a record high in nine years. The euro area GDP rose on quarterly basis by 0.1 percent in the first quarter. In the second quarter, weak investment, sluggish consumption and the appreciation of the euro exacerbated difficulties for exports, and the economy started to show a trend of stagnation. The jobless rate rose to 3-year high of 8.8 percent in April. Japan's GDP also expanded by 0.1 percent in the first quarter with the unemployment rate hitting 5.4 percent. PPI and CPI declined continuously due to weak domestic demand and the situation of deflation remained unchanged. The growth of most economies in Southeast Asia slid to some extent, but still maintained relatively strong growth momentum on the whole.

 

The turbulence in international financial markets intensified in the first quarter. The depreciation of the US dollar continued after the concluding of the war on Iraq due to massive trade and fiscal deficits of the US. In the second quarter with the waning of the uncertainty caused by the war, bond yields declined accompanied by stock price rise in the US, the euro area and Japan. In June, the European Central Bank and the Fed cut interest rates in succession, further spurring the growth in equity markets. From April 1 to the end of June, the Dow Jones Industrial Average rallied by 12.5 percent, and the FTSE and Nikkie indices gained 13.6 percent and 14.2 percent respectively.

 

The developed countries continued to pursue accommodative monetary policies, leaving the scope for macroeconomic policy maneuver shrinking. In early May the Bank of Japan decided to purchase asset backed securities of enterprises to expand channels of direct financing for enterprises. Following a rate cut in March, the European Central Bank reduced the refinancing rate by 0.5 percentage points to a historical low of 2 percent on June 3. On June 25 the Fed lowered the federal fund interest rate by 0.25 percentage points to 1 percent, a record low since 1958. On July 6 the Bank of England cut base interest rate by 0.25 percentage points to 3.75 percent, the lowest level since 1955.

 

Box 5    Japan's Bubble Economy   In September 1985, in order to address the situation of large trade surpluses of Japan against the US and the appreciation of the US dollar, the meeting of the finance ministers and central bank governors of the US, Japan, the UK, France and former West Germany was convened in Plaza Hotel in New York under the scheme of the US. A decision was made to heavily intervene in the foreign exchange markets jointly to devalue the US dollar against the Yen and the European currencies, which is referred to as "Plaza Agreement" in history. As a result, the value of the Yen against the US dollar soared from 240:1 in September 1985 to 120:1 in early 1988.   The sharp appreciation of the Yen brought pressures to Japan's export-oriented economy. Japan began to pursue relatively easy financial and fiscal stances, with a view to preventing economic growth from sliding and to boosting domestic demand. The Bank of Japan cut interest rates five times during the period between January 1986 and February 1987 with the discounting rate falling from 5 percent to 2.5 percent, a historical low level. The course of financial liberalization in Japan starting from the 1980's, which focused on interest rate liberalization and lifting restrictions on the business scope of banks, also led banks to relax conditions for granting loans, thus enterprise loans and bonds continued to expand. During 1987-1990 the volume of internal and external financing of Japanese enterprises grew by one fold in average from four years earlier. In the meantime, the Bank of Japan purchased the US dollar and sold the Yen massively in the foreign exchange market to guard against continued appreciation of the Yen. Therefore money supply expanded rapidly with the growth rate hitting over 10 percent in 1987, resulting in more than adequate market liquidity.   Against the background of easy financial policies and abundant financing, Japan experienced a new wave of investment. The long-lasting low interest rate even further stimulated the continuous hike of land and stock prices. From 1984 to 1989, land price in Japan rocketed by around two folds. At the end of 1987, Japan's equity market outgrew the US to rank first in the world. The skyrocketing price inflation of assets such as land and stock unusually exceeded GDP growth, inflaming "bubble economy" featuring "real estate bubbles", "securities bubbles" and "banking bubbles". Nonetheless, although money supply grew much faster than nominal GDP during 1986-1990 and real GDP also gained, major indicators of monetary policy—consumer prices of common commodities almost remained unchanged at the original level.   In face of rapid growth in money supply and loans and asset price hike of land and stock, but no rise in consumer prices, the Bank of Japan cautioned against the excessively rapid banking loan growth, pointing out that prudent approach should be taken in extending loans to real estate and stock investment to ensure sound business operations and reminding financial institutions of being vigilant to excessively large size of loans. But the Bank of Japan failed to take concrete policy measures in a timely manner. In Japan, politicians, media, businesses and households generally thought that the fluctuations of asset prices would have tiny impact on the economy and that focus of policies should be placed on promoting economic growth.   The outgrowing of money and credit against the real economy for consecutive yeas resulted in extreme money easing and increasing potential inflation pressures. Against the backdrop of interest rate rises in many countries, the Bank of Japan began to increase the discounting rate in 1989 with the financial conditions reversing from expanding to rapidly contracting. Stock and land prices slumped and enterprises suffered from worsening financial performance and inadequate liquidity. Financial institutions such as banks accumulated huge amount of non-performing loans due to enterprise bankruptcies. Financial crisis further exerted great impact on the real economy, then the "bubble economy" burst and the Japanese economy stagnated, plunging into ten years' recession.

 

II. Macroeconomic performance in China

 

China has withstood the negative impacts of the war on Iraq and the outbreak of SARS epidemic and maintained the sound momentum of economic growth since the beginning of the year. In the first quarter GDP rose by 9.9 percent, recording the fastest level for the period since 1996. In the second quarter, consumer demand fell by a large margin due to the outbreak of SARS epidemic, while fixed investment and net exports maintained strong growth. In the first half of the year GDP exceeded RMB5 trillion yuan, up 8.2 percent over the same period of the previous year. Consume prices continued to remain at subdued levels.

 

1.      Demand analysis

 

Consumer demand declined slightly. In the first half of the year retail sales of consumer goods amounted to RMB2.2 trillion yuan, up 8 percent or 0.6 percentage points lower than the same period of the previous year. In May, the month most affected by SARS, retail sales of consumer goods reached RMB346.3 billion yuan, up 4.3 percent only and decelerating by half over the same period last year, the slowest growth for the period since 1991. With the weakening of the SARS effect consumer demand began to pick up. In June, retail sales rose by 8.3 percent compared with the same period last year.

 

Fixed asset investment maintained strong growth and technology upgrading and renovation investment accelerated markedly. In the first half of the year, fixed asset investment amounted to RMB1.9 trillion yuan, up 31 percent or accelerating by 10 percentage points over the same period of the previous year, the highest level for the period since 1995. Infrastructure investment and real estate investment maintained rapid growth, and technology upgrading and renovation investment increased by 39.2 percent, accelerating by 23.1 percentage points over the same period a year earlier.

 

Net exports continued to expand. In the first half of the year, total trade volume reached USD376.1 billion, up 39 percent and an acceleration of 26.7 percentage points over the same period last year. Exports amounted to USD190.3 billion, up 34 percent and imports amounted to USD185.8 billion, up 44.5 percent with the trade surplus reaching USD4.5 billion, down by USD8.9 billion over the same period of the previous year. Breaking down by month, in the first three months, external trade recorded deficit due to a large amount of oil imports and mass imports of automobile accessories following tariff cuts. In April foreign trade registered a surplus of USD1.02 billion, and the surplus hit USD2.2 billion in both May and June. Foreign direct investment dropped slightly in May due to the impact of the SARS outbreak, but maintained strong growth in other months. In the first five months, FDI grew by 48.2 percent, much higher than the growth of 12.4 percent recorded in the same period last year.

 

Box 6    Inventory and Economic Growth   Measured by expenditure approach, GDP is composed of final consumption, gross capital formation and net exports of goods and services. Of them, gross capital formation consists of gross fixed capital formation and inventory increase. The production and sales sectors are major holders of inventory. For the production sector inventories include raw materials, semi-products and finished goods. For the sales sector, inventories mainly refer to stocks of goods that have not been sold.   In mature market economies inventory carries cyclical feature. Inventory rises during boom and slumps during recession. Inventory can be used to sooth production fluctuation and avoid sales decline. Furthermore, inventories can be increased at low price levels for speculation. Inventory cycle is an important sub-cycle of the whole business cycle. The ratio of inventory increase to GDP can reflect the degree of marketization of an economy. In mature market economies the ratio of inventory increase to GDP is very low, usually below 1 percent.   Before the mid 1990's, inventory stood at a high level in China. During 1978-1995 the ratio of inventory increase to GDP averaged at 6.7 percent in China with the highest level hitting 10 percent in 1989. The main factors behind this were that China's enterprises used to focus on production and pay little attention to marketing. With the deepening of state owned enterprise reform, enterprises have attached more importance to marketing since the mid 1990's. In particular, market plays a stronger role in determining enterprises' production, and the Chinese enterprises have to adapt to market conditions to reduce inventory since 1998. The ratio of inventory increase to GDP was 2.4 percent in 1998. It further fell to minus 0.1 percent in 2000 and stood at below 1 percent for three consecutive years (see Figure 6). Since the second half of 2002, enterprise inventory level has increased gradually with the quickening pace of industrial production.   Figure 6 Change in Inventory and Economic Growth      Source: China Statistical Year-Book 2002, China Statistical Summary 2003   At the end of June 2003, the stocks of semi-products of statistically large industrial enterprises amounted to RMB795.6 billion, up 27.3 percent or an acceleration of 6.3 percentage points from a year earlier. In the first half of 2003, the sales ratio of industrial goods reached 97.15 percent, up 0.1 percentage points on the same period of the previous year. The ranking survey of supply and demand of 600 major goods made by the National Bureau of Statistics showed that the oversupply of commodities eased somewhat. In the first half of the year, the commodities that enjoyed basic equilibrium between supply and demand accounted for 14.5 percent of the total, up 1.5 percentage points from the second half of 2002. The commodities in oversupply accounted for 85.5 percent, down 1.5 percentage points from the second half of 2002. It is noticeable that because the SARS epidemic caused decline in orders of some sectors and enterprises, inventory is likely to further climb in the periods ahead. Therefore close monitoring on inventory increase need to be conducted. Commercial banks should pay close attention to the production and operation activities of enterprises that loans are offered and strengthen management of loan quality.

 

2.      Supply analysis

 

Industrial production registered rapid growth. In the first half of the year industrial value added amounted to RMB1.8 trillion yuan, up 16.2 percent, accelerating by 4.5 percentage points over the same period of the previous year. The production/sales ratio in the first half of the year hit 97.15 percent, up 0.1 percentage points. Economic returns of industrial enterprises further increased. In the first half of the year net profits of industrial enterprises amounted to RMB 363.8 billion yuan, up RMB 131.7 billion yuan or 56.7 percent.

 

The enterprise capacity utilization was elevated. Business activity survey of 5000 industrial enterprises in the second quarter made by the People's Bank of China showed that enterprise operating over capacity accounted for 4.58 percent of the total, enterprises operating with full capacity accounted for 74.16 percent and enterprises operating below capacity accounted for 21.26 percent. The diffusivity index of capacity utilization was –16.7, the best level since 1992, up 1.2 and 6 points from the first quarter and the same period of the previous year respectively.

 

Enterprises enjoyed adequate financing. The business activity survey of 5000 industrial enterprises showed that at the end of May capital balance of surveyed enterprises stood at RMB486.7 billion yuan, up 20.6 percent year on year and the highest level since October 2001. The turnover of working capital in enterprises was 245 days, down 48 days over the same period a year earlier. The questionnaire survey showed that enterprises with relatively strong payment ability accounted for 23.15 percent, enterprises with normal payment ability accounted for 60.82 percent and enterprises with worsening payment ability accounted for 16.03 percent. The diffusivity index of payment ability reached 7.1, up 1.2 and 8.3 points over the first quarter and the same period of the previous year respectively.

 

*Note: The diffusivity index is calculated on the basis of the result of business climate survey. The survey requires every enterprise to answer "up",  "same" or "down" or "increase", "unchanged" or "decrease" for each question. The diffusivity index is the proportion of "up" enterprises minus the proportion of "down" enterprises multiplied by 100. The figure stands between 100 and minus 100. The rise and decline of the diffusivity index translates into rise and decline of business climate correspondingly.

 

3.      Price development

 

Consumer price kept rising. In the first six months consume price index rose by 0.6 percent over the same period of 2002. In the first and second quarters CPI climbed by 0.5 and 0.7 percent respectively. Breaking down by month, CPI rose in moderation by 1 percent, 0.7 percent and 0.3 percent respectively in April, May and June. (See Figure 7)

 

The rise of producer prices moderated. Producer prices of industrial products increased by 2.9 percent in the first six months over the same period of 2002 and by 3.6 percent and 2.3 percent in the first and second quarters respectively. The index rose by 3.6 percent, 2 percent and 1.3 percent respectively in April, May and June. Enterprise commodity prices monitored by the PBC climbed by 1.1 percent in the first six months with a gain of 1.6 percent, 1 percent and 0.8 percent respectively in April, May and June.

 

Figure 7: Prices Movement

 

Source: The National Bureau of Statistics and the People's bank of China

 

The rise in overall price levels since the beginning of the year can be directly attributable to the increase in food price and international crude oil price. The rise of food price was mainly caused by the seasonal factors of the Spring Festival in January and February and the SARS outbreak in April and May. The hike of international crude oil prices was mainly caused by the war on Iraq. In terms of economic fundamentals, strong growth of investment demand together with sharp increase in money and credit were the main factors underlying the price rally this year. Constrained by many factors, however, such a rally is unlikely to go too far. On the one hand the oversupply of consumer goods will remain unchanged, on the other hand production excess capacity will persist.

 

III. Industrial performance

 

In the first half of 2003 the primary industry expanded steadily, up 2.7 percent over the same period last year. The secondary industry recorded accelerated growth, up 11.6 percent. Affected by the SARS outbreak, the tertiary industry growth slowed down to 4.2 percent.

 

Figure 8: Proportions and growth change of the primary, secondary and tertiary industries in the economy

Source: China Economic Activity Monthly Bulletin

 

1.Analysis of industrial sectors

 

By sector, in the first half of the year, the turnaround of economic activity pushed growth in the fundamental raw material sector. In the first six months, output of crude coal, steel, cement and electricity increased by 16.3 percent, 21 percent, 15.1 percent and 15.4 percent respectively. The upgrading of consumption structure boosted the development of the automobile, home electric appliances, high-end electronic products and electronic component sectors. During January-June, the automobile output grew by 32.2 percent, while the production of mobile communication equipments and automatic exchange machines declined due to oversupply.

 

The majority of sectors registered marked increase in profits. In the first half of the year, of 39 broad categories of industrial sectors 37 sectors witnessed profit increases over the same period last year. Oil and gas exploration, transportation equipment manufacturing, ferrous metallurgy and mangling processing, chemical material and chemical products manufacturing and generation and supply of electricity and heat were the sectors that made most profits. The above-mentioned five sectors made a total of RMB 82.1 billion yuan profits, accounting for 62.3 percent of the total industrial profits.

 

At present, the irrational industrial structure is the major problem facing China's industrial development. Some sectors with excess capacity are still expanding indiscriminately. A new round of duplicated construction is bound to exacerbate industrial imbalance. Sectoral duplicated construction is mainly reflected in the following four aspects: fist, some low efficiency small coal mines, steel plants and cement plants with high energy consumption and pollution reemerged. Second, various development zones were set up in a disorderly manner in violation of regulations. Some localities sold land at low prices or for free in the name of developing high and advanced technologies and exempt or reduce taxes at their discretion, leading to increasing sectoral convergence. Third, the real estate sector experienced overheating in certain regions. Fourth, competition within the automobile industry intensified.

 

In terms of the source of financing for the current continued strong growth in fixed investment, the share of bank loans continued to rise while that of other financing sources declined relatively. (See Table 5) Financial sectors must attach great importance to potential risks of repetitive construction and nip them in the bud.

 

Table 5: The Weight of financing sources of fixed investment

 In percent

 

Source: The National Bureau of Statistics

 

2.      Spotlight: electricity

 

The electricity sector has sustained rapid growth since 1998 with rising proportion of electricity supply in gross energy production. In 2002 electricity generation amounted to 1.6 trillion kilowatts, of which thermal power reached 1.3 trillion kilowatts, accounting for 82.9 percent and hydropower reached 246.5 billion kilowatts, accounting for 15.4 percent. (See Figure 9) Electricity generation rose by 15.4 percent, up 6.6 percentage points over the same period last year.

 

Some regions have experienced structural tension in electricity supply and demand since the second half of 2002 due to increased electricity demand driven by strong economic growth. Some electricity grids encountered problems of power shortage and blackouts during peak periods. In the first half of 2003, regions suffering from shortage of power extended somewhat, 16 provinces experienced blackout compared with 11 provinces last year. In the first five months, the rate of capacity utilization that is measured by average working hours of generation facilities rose to 57 percent, the highest level since the beginning of the ninth-five-year plan period. This year a batch of construction projects of power supply and power grids have been approved to further expand power supply capacity. However, the tensions in power supply and demand in China will persist in the next few years due to increasing power demand.

 

Figure 9: Development of the Electricity Sector Since 1998

Source: China Statistical Yearbook

 

Box 7 The Impact of SARS on China's Economic  and Financial Performance   According to the statistics of the WHO, a total of 32 countries reported SARS cases or suspect cases by June 25. The number of global SARS patients reached 8460, and 808 died of the epidemic with the mortality rate hitting 9.6 percent. According to the statistics of China's Ministry of Health, 26 provinces and municipalities reported SARS cases by June 26, the number of patients reached 5327 and 348 patients died of the disease with the mortality rate standing at 6.5 percent.   Tourism, passenger transportation, commerce and hotel and catering are among the sectors hit hard by the SARS outbreak. In April and May when SARS was most rampant, the tourism industry sank into stagnation. The volume of passenger transportation fell sharply and the civil aviation and railway industry registered losses. Commerce and catering shrunk markedly. In May retail sales of consumer goods only grew by 4.3 percent. Nevertheless, sectors including tourism, catering, entertainment and education have begun to recover since June and panic among the people receded substantially. Except for the above mentioned sectors, SARS didn't have much impact on other industries, especially fundamental industries such as energy and raw materials which underpinned the strong growth of industrial production and fixed investment. In addition, sectors related to prevention and treatment of SARS mushroomed during the SARS period. In May medical and pharmaceutical output expanded by 35.4 percent over the same month of the previous year, the fastest growth among all industrial sectors. Detergent production increased by 36.7 percent. Both production and sales of automobiles and communication equipment were vigorous and sport goods, electric fans, disinfection cupboard, bicycles and electric bicycles witnessed marked acceleration of sales growth.   The lagging impact of the SARS outbreak mainly affected exports, employment and farmer's income. During the SARS period, some enterprises suffered from decline in orders and would be unable to make up for those lost orders. The outbreak of the SARS epidemic also resulted in sharp decrease of new job offers in service sectors, aggravating the already severe employment tensions. Moreover, the SARS epidemic forced 7-8 million rural migrant workers to go home so that farmer's cash income declined in the second quarter, worsening the situation of farmer's income growth for the whole year.   On June 24, the WHO announced its lift of traveling ban to Beijing and delisted Beijing from the SARS affected areas. Macroeconomic data in June showed that the Chinese economy was putting the adverse impact of SARS behind it and maintained sound momentum of stable and rapid growth. As an unexpected and emergent event, SARS had some impact on the Chinese economy, but the impact was temporary, partial and limited, without undermining China's economic fundamentals. SARS didn't affect the trend of strong growth of money and credit, but the possible impact of SARS on loan quality deserves close monitoring.

 

 

 

Part Five       Projections and Outlook

 

I. Global and domestic economic and financial outlook for the second half of 2003

 

In the second half of 2003, the effects of interest rate reduction and tax cut in major economies will gradually unfold and the pace of global economic recovery will moderately pick up. According to the forecasts of UN in its Global Economic and Social Survey 2003 published on June 25, although some geo-political factors including the war on Iraq which have affected global economic recovery are fading away, the pace of global economic recovery will remain slack as trade and investment showed continued weakness. The world economy is expected to grow by 2.25 percent this year, slightly faster than the 2 percent growth in the previous year. The global trade is expected to grow by 4 percent, higher than the 2 percent increase of the previous year. Foreign investment will continue to be lacklustre.

 

Financial markets in advanced countries will remain quite volatile. On exchange rate front, the US dollar depreciated by widening margin in May, but revalued back against the euro and the yen recently. Both Japan and US are likely to continue the expansionary monetary policy. Chairman Greenspan even expressed that strategies such as purchasing financial assets that are usually regarded as unconventional might be adopted in the future. If the deflationary pressure further intensifies, the European Central Bank suggested it would not rule out the possibility of further interest rate cut.

 

Weak global economy, ie, growth is likely to further strengthen inter-national trade protectionism, which may in turn curb China's export growth and add pressure on the revaluation of RMB. The destination of global capital flows basically remains unchanged, which is conducive for China to utilize foreign investment effectively.

 

Based on comprehensive analysis, the negative impact of the SARS outbreak on the Chinese economic growth for the whole year appears to be limited and the economy will maintain its sound growth momentum. However, the better than expected economic situation does not warrant a sense of complacency and more importance needs to be attached to studying and resolving acute problems arising in the course of economic and social development. First, in-depth analysis should be conducted and great attention be paid to examine the reasons behind the current rapid growth of loan and the risks that might incur. Second, vigilance should be kept to irrational investment and duplicated construction in some regions and sectors that might aggravate economic structural imbalance. Third, great efforts should be made to explore ways to create more jobs and increase farmer's income. Fourth, credit access for small and medium sized enterprises (SMEs) should be continuously expanded to support the development of the SMEs. Fifth, the impact of global economic development and other significant unexpected events on the Chinese economy should be closely monitored so as to work out responsive measures in a timely manner.

 

In the second half of the year, China will adhere to the principle of expanding domestic demand so as to maintain policy continuity and stability. The focus of various tasks will be placed on adjusting economic structure and improving the quality and efficiency of the economic growth.

 

II. Monetary policy stance in the second half of 2003

 

1. Continue to implement the sound monetary policy and maintain steady growth of credit

 

In the second half of the year, the PBC will continue to implement sound monetary policy to maintain the continuity and stability of the monetary policy. Developments in global and domestic economic and financial performance should be closely monitored and surveillance over credit strengthened. The direction and scope of monetary policy adjustments should be well managed and various monetary policy instruments adopted to maintain steady growth of credit so as to keep the sound momentum of economic and financial development.

 

2. Continue to improve financial service aiming at supporting job creation and farmer's income rise

 

Various policies aiming at improving credit service to SMEs will be continuously carried out. Guaranteed small-value loans to laid-off workers and unemployed people will be extended to increase job opportunities. Consumer credit policy will be further improved to promote healthy development of housing, automobile and education loans. Active support will be rendered to the pilot reform of rural credit cooperatives and small-value loans to rural households will be continuously expanded so as to increase farmer's income. Meanwhile, various financial policies for supporting west region development will be continuously implemented.

 

3.      Prevent duplicated construction and guard against financial risks

 

Proper window guidance will be given to commercial banks to guard against potential financial risks associated with rapid growth of credit and to strengthen early warning of surveillance over loan risks. Commercial banks will be also required to further optimize loan structure to prevent duplicated construction, forestall new occurrence of loan risks and accelerate reform.

 

4.      Maintain basic stability of RMB deposit and loan interest rates and steadily push forward market-based interest rate reform

 

In the second half of the year, base interest rates of RMB deposits and loans will be kept basically stable. On the other hand, market-based interest rate reform will be pushed forward steadily with experiences gained both at home and abroad,.

 

5.      Maintain basic stability of RMB exchange rate and further improve the RMB exchange rate regime

 

RMB exchange rate will be kept basically stable as well. On the basis of adhering to the managed floating exchange rate system supported by market supply and demand of foreign exchange, the exchange rate regime will be further improved to promote equilibrium of the balance of payments.

 

6.      Strengthen construction of credit information system and speed up the establishment of the nationwide enterprise and individual credit reporting arrangement

 

Based on experiences attained from the domestic pilot project and foreign countries, the establishment of the nationwide enterprise and individual credit reporting system will be accelerated to promote development of financing in various forms. First, the existing laws and regulations will be gradually amended and improved so that the construction of the credit information system will be carried out within a sound legal framework. Second, planing and coordination of the construction of the nationwide credit reporting system will be strengthened to expedite setting unified technology standard and extend the coverage of the pilot project. Third, the building of an integrated data exchange platform for the nationwide credit information system will be speeded up. Fourth, intermediate institutions will be guided to promote credit culture development in a market economy.