[Viewpoint] How China is guiding its economy

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[Viewpoint] How China is guiding its economy

Before the Lunar New Year, China raised the deposit reserve requirement ratio by 0.5 percent. The move raised concerns that Beijing is pursuing fiscal austerity.

China is a socialist country with many variables. Its internal trends might not be visible if you are looking through a capitalistic telescope. But if you use a microscope, you can understand Beijing’s intentions.

Considering the domestic situation in China, the loan restriction and deposit reserve requirement ratio increase are far from a retrenchment policy. The 0.5 percent increase in the deposit reserve requirement ratio is a measure to collect the money released during the Lunar New Year. In time for the biggest holiday, Beijing released 700 billion yuan ($102.4 billion, 117.84 trillion won) into the market. Considering that total deposits in China are 61 trillion yuan, the effective result of raising the reserve requirement ratio would be the collection of 610 billion yuan.

Why does Beijing surprise the world by meddling with the deposit reserve requirement ratio when a similar result can be achieved more simply by raising interest rates? Basically, China is not a system sensitive to a change in interest rates. Unlike Korea, many of the large Chinese conglomerates, who are the main users of capital, are state-run companies with close relationships with local governments.

Local governments value employment and the GDP growth rate. The presidents of these state-run companies are appointed public servants. Regardless of the interest rates and corporate revenue, they continue to make investments to boost the growth rate. Therefore, regulating the money supply works better than adjusting interest rates or restricting loans.

While China grew by 8.7 percent last year, investment grew by 8 percent. Behind the excessive dependency on investment are new loan issuances of 9.6 trillion yuan. If the trend continues this year, GDP growth will be over 16 percent. The Chinese government is working to lower the portion of GDP growth that is dependent on investment to 50 percent and increase the portion dependent on consumer spending. In January, 1.4 trillion yuan was loaned, which is 15 percent of last year’s total loans. So the authorities are intervening. The retrenchment in China is strictly a reduction of excessive investment.

When will China increase interest rates? China’s real interest rates, unemployment rate and the value of the yuan should be considered together. Beijing thinks that a 3 to 4 percent price increase can be buffered if the GDP grows by 10 or 11 percent. If prices rise by 4 percent for more than three months in a row, the interest rate could be increased. China’s fixed deposit interest rate is 2.25 percent, so if the prices rise by more than 3 percent, the real interest rate would be negative. In that chase, authorities are likely to increase the interest rates. At present, inflation is 1.5 percent, so Beijing does not fret about it for now.

As exporting companies are filing for bankruptcy, over 20 million workers lost their jobs, and major industries are struggling with a supply surplus. While the official unemployment rate is 4 percent, it is likely to be double in reality. Many Western countries discuss a possibility of interest rate increase and upward revaluation of the yuan, but it is an unlikely scenario considering China’s domestic circumstances.

If interest rates are increased, it would attract hot money and add pressure to revaluate the yuan. China is struggling with currency management as $400 billion of foreign currency flows into the country every year. A 5 percent revaluation would result in a $120 billion loss in foreign currency reserves of $2.4 trillion. Beijing is even more scared of increasing unemployment as a result of bankruptcies of the companies whose profit margins from exports are less than 5 percent.

Recently, the United States decided to export $6.4 billion worth of weapons to Taiwan. Predictions for revaluation of the yuan are discussed in Washington, but there is no possibility that Beijing would respond to Washington’s demand. China thinks it is ridiculous for a debtor to intervene in a lender’s affairs. Beijing is continuously reducing its holdings of government bonds except for the U.S. Treasury securities.

If China raises interest rates first, it would suffer a loss, so Beijing will follow if the U.S. Federal Reserve makes a move. China is likely to manage its currency by raising the deposit reserve requirement ratio and regulating loan issuances over two or three occasions and delay an interest rate hike. China could be pressured by price increases in the second quarter, but if it manages to endure this period, it could enter a more stable phase in the second half. If interest rates are not increased in the second quarter, they might not raise them at all this year.

This year, China changed the 30-year-old development strategy and shifted focus to boost domestic demand. In January, electricity consumption increased by 40 percent, and income expanded by 85 percent, partly because of the Lunar New Year holiday. Last year, China enjoyed a boom in electronics and automobile demand through government?led stimulus policy, and this year, government subsidies are expanding to construction materials, broadband communications and motorcycles.

Now, what Korea needs to pay attention to is not the deposit reserve requirement ratio but expanding domestic consumption in China. The biggest beneficiary of China’s growing demand will be Korea, which provides intermediate materials. If Korea rides with the expanding domestic demand in China, it might find a way to be well off for the next 10 years.

*The writer is a professor of Chinese business at Kyung Hee University.
Translation by the JoongAng Daily staff.

by Chon Byeong-seo
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