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China Environmental Export Market Plan
Chapter 2 - Economic Overview
Chapter 2 - Economic Overview

China's economy has seen consistent growth since Deng Xiaoping's policy of economic reform and opening began in 1978. For much of the 1980s and early 1990s, the nation enjoyed double-digit rates of GDP growth. That growth began to slow, however, in 1992, and remained in decline as a result of inflation, fallout from the Asian financial crises, sluggish domestic demand, rising unemployment, and eventually deflation. In early 2001, the economy began to show preliminary signs of picking up, with GDP growth nearing 8 percent (the official target for 2000 was 7 percent), consumer prices slowly rising, and exports gaining strength as the rest of Asia began shedding the influence of the Asian financial crises.

Economic predictions for the coming years range from moderate to cautiously optimistic. Most predictions call for annual GDP growth of 7-plus percent over the next two to three years. Recent increases in domestic demand are viewed as potentially sustainable and may be a sign that the country's deflationary spiral has come to an end. Consumer spending on such substantial items as residential property rose an estimated 40 percent in 2000 and will likely continue to increase. Nonetheless, domestic demand remains sluggish and continues to present a macroeconomic concern.

The most promising indicator that GDP growth will be sustained at over 7 percent is the current fiscal policy. Much of China's growth over the past several years has been heavily influenced by large amounts of government spending, and it is clear that this spending will continue. Since 1998, the country has issued RMB 360 billion ($43.5 billion) in government bonds to fund fiscal-stimulus spending on infrastructure development. A probability model developed by the State Information Center indicates that GDP growth for the year 1999 would have been 4.3 percent instead of 7.0 percent if the bonds had not been issued and the funds allocated as they were.

Bonds funded 46 percent of government spending in 1998, whereas in 1993 they accounted for 3.8 percent of expenditure. Approximately 15 percent of 2001 government expenditure was earmarked for interest payments. The country's debt burden is currently considered sustainable; however, it is unclear how long this deficit spending will continue.

The Financial Burden

The assessment of China's finance and debt structure is somewhat different, however, if financial sector reforms, SOE reforms, pension reforms, and agricultural reforms are taken into account. The World Bank singles out these four sector reforms as the major financial burdens on China's economy, each of which requires creative macroeconomic management on the part of policy-makers. According to the World Bank, the one temporary reprieve is China's exceptionally large stockpile of personal savings, which equals around 40 percent of GDP. WTO entry is gradually opening the domestic banking sector up to foreign banks, which may draw some assets away from the state.

China's banks are burdened with tremendous amounts of non-performing loans paid out to SOEs that are based more on political interests than on commercial viability. According to the People's Bank of China, approximately 20 percent of outstanding loans in the biggest state-owned banks are non-performing, 75 percent of which can likely be recovered. Outsider estimates of non-performing loans vary (25-40 percent non-performing, with only about 15 percent recoverable, is not unreasonable), but the widespread consensus is that the People's Bank of China's estimate is significantly understated. In sum, non-performing loans are estimated at $180-360 billion, or 18-36 percent of 1999's GDP.

Recently, the central government instituted a debt-to-equity swap system by which banks were relieved of a percentage of their bad loans. Asset management companies have been established to acquire percentages of selected SOEs' debts and turn them into equity. These companies, which become part owners of any SOEs for whom they have acquired debt, are expected to restructure the enterprises, and make them profitable. Thus far, the scheme has done little more than relieve the banks and some SOEs of a degree of the strain resulting from the debt burden. Significant changes in management policy are necessary if reduced burdens are to improve financial management (on the part of the banks) as well as enterprise management, production efficiency, and profitability (on the part of the SOEs). So far there has been little sign of such changes.

Significant downsizing is also underway in the state-owned sector. Under a strategy of - grasping the large and letting go of the small, - the government is working to turn some of the larger SOEs around, hoping they will develop into self-sufficient, profit-oriented, giant international corporations. At the same time, many of the smaller SOEs have been left to the devices of local governments, resulting in significant closures and layoffs.

SOE reform and low profitability in the sector have led to the functional disintegration of the SOE-based social security system, resulting in a growing implicit pension debt. Loss-making SOEs are no longer able to fund workers' housing, health care, education, and pensions, all of which are responsibilities that traditionally rested with SOEs and work units. Some of these funds, which are estimated at $240 billion, will need to materialize. The same holds true for money needed to support the country's rapidly aging population.

Finally, the agricultural sector, historically the country's primary economic sector, is now viewed as the economy's weak link. Farmers' incomes have risen slowly in comparison with incomes in other sectors and accession to the WTO may have negative effects that lead to even poorer overall performance.

Structural Changes

It is the assessment of the World Bank that China is undergoing four types of structural change. Any one of these changes could result in a significant reallocation of resources or income distribution, affecting the economy as a whole. However, all four changes are occurring simultaneously:
Other Factors of Influence

Other factors that influence the overall performance of the nation's economy should also be recognized:
Economic Development and Environmental Investment

Pollution Control Investment

According to CRAES, the leading SEPA think tank, national economic development and environmental investment in China have been closely related over the past 15 years. As GDP grew, so did rates of total investment in pollution control. In fact, TIPC's percentage of total GDP increased even as the GDP growth rate slowed. Investment during the eighth Five Year Plan was 2.7 times that in the seventh Five Year Plan, and Ninth Five Year Plan expenditure exceeded that of the eighth. Environmental investment's average percentage of GDP rose from 0.6 percent in the seventh Five Year Plan to 0.77 percent in the eighth. By the end of the Ninth Five Year Plan, investment reached 1 percent of GDP.

TIPC as a percentage of total national investment in fixed assets also showed overall growth. TIPC averaged 2.41 percent of total national investment in fixed assets during the seventh Five Year Plan, peaked in 1991 at 3.09 percent, dipped in the mid-1990s, and trended upward after 1995 to reach 2.76 percent in 1999.

Remarks attributed to Xie Zhenhua, the minister of SEPA, indicate that environmental investment reached 1 percent of GDP in 2000, and is expected to reach 1.3-1.5 percent over the next five years. Official forecasts are calling for RMB 700 billion ($84.6 billion) in environmental investment over the course of the Tenth Five Year Plan. In some major coastal cities such as Beijing, Shanghai, Dalian, Qingdao, and Xiamen, environmental spending has reached as high as 3 percent of GDP. However, it should be noted that the definition of environmental protection is quite broad and inconsistent in China. It may include urban beautification and other activities not normally categorized as environmental protection elsewhere. Thus, figures for annual environmental spending cited in various Chinese publications may vary as much as 15 percent depending on the sources of data and methods of calculation.
Figure 2.1 Total Investment in Pollution Control (TIPC) as a Share of Chinese GDP and of Total National Investment in Fixed Assets, 1991-1999 (percent)

Source: Sinosphere Corp., from data reported in Cao and Sung. Environmental Financing in China.

Macroeconomic Perceptions and Finance Tools

The steady development of China's economy has increased investor confidence in macroeconomic stability, opening up potential for the use of financial tools such as stocks and bonds. Although both stock and bond markets in China have a considerable way to go before they can be considered comprehensively developed, they are facilitating some degree of environmental investment. State Development and Planning Commission (SDPC) reports indicate that a significant portion of the $43.5 billion in government bonds used for fiscal-stimulus spending on infrastructure development since 1998 has been directed toward environmental protection and the management of natural resources. The investments have reportedly increased daily wastewater treatment capacity by more than 8 million tons and solid waste treatment capacity by 31,000 tons. Centralized heating, flood control, forest management, and capacities to extract and use natural gas also reportedly benefited.

Over 30 environmentally related companies are currently listed on China's stock exchange, with reportedly high degrees of success. Stock markets in China have become a tool for gaining quick infusions of financing from small-scale Chinese investors, particularly personal investors. However, the relatively under-developed and somewhat dubious nature of the country's stock markets prevents them from being more readily exploited for the purposes of environmental financing. (China's stock markets are discussed further later in this chapter.)

There is discussion within government think tanks regarding the development of bond markets, publicly traded investment funds, and other financial tools to be focused on environmental sector investment. The effective use of these tools would greatly reduce the financial burden currently shouldered by government budgets. However, a more developed and better regulated financial sector is required before such tools can reasonably be expected to perform in this capacity. Experts have suggested that the necessary climate for such tools will not develop during the Tenth Five Year Plan, and perhaps not even during the 11th. (See Chapter 9 for a discussion of finance programs and resources.)

Institutional Changes, Decision-Making, and Efficiency

China's gradual shift from a command and control economy to a market economy has caused a slow decentralization of decision-making power. The responsibilities of different stakeholders within the financial decision-making process (such as banks, local governments, and enterprise managers) are being increasingly clarified. Liability for performance outcome, and therefore financial and enterprise efficiency, is on the rise.

Particularly among such high-profile and economically important SOEs as Sinopec and Baosteel, as well as among SOEs in some of the more economically and environmentally developed regions of the country, industrial efficiency and financial bottom lines are becoming more and more important. Reportedly, industries with progressively oriented management and the commercial potential for successful reform are being given increased flexibility to make investment and management decisions with decreased interference by the central government. Efforts to increase operational efficiency through cleaner production, improved management, and improved equipment maintenance are already being seen and are expected to increase.

Privately-owned enterprises, which by their very nature are more entrepreneurial and competitive than their state-owned counterparts, have a stronger vested interest in efficiency than even the most successful and personally responsible SOEs. The non-state sector is on the rise and is expected to grow significantly in the near term. Financial and investment tools remain out of reach for most private enterprises, making efficiency that much more important. (For a detailed analysis of China's private sector, see the International Finance Corporation's "China's Emerging Private Enterprises," available online at www.ifc.org/publications.)

Environmental Prospects for the State-Owned Sector

Unlike those SOEs with potential for commercial success, discussed in the previous section, many of the country's SOEs are caught in a downward spiral of poor viability and tremendous burden. Efforts to downsize and close large numbers of those SOEs that show little or no hope of reform and future profitability have been underway for some time; however, mass layoffs and severance of numerous benefits such as health care and housing carry significant social impact. Thus, smaller SOEs are being dissolved while many of the larger ones are being kept afloat not so much in hopes of turning them around but simply to prevent mass numbers of people from becoming disenfranchised.

Many SOEs, particularly those in China's northeastern - rust belt, - rank as some of China's worst polluters. Some facilities in the area date as far back as the Japanese occupation of the 1930s and 1940s, and have efficiency capacities to match. Appropriate upgrades could benefit both the efficiency and the environmental performance of these enterprises significantly, and some degree of return would likely be seen relatively quickly. However, the required initial capital is extremely difficult to secure, and many such enterprises would face considerable difficulties in paying back loans from both public funds and commercial lenders even if they were to begin seeing improved financial outcomes as a result of increased efficiency.

Institutional Changes and Financial Liberalizations

Changes in China's economic and financial institutions are occurring rapidly and may have a tremendous impact upon the future development of the economy. No matter how committed the government is to environmental protection in China, there is little hope for success without the economic capacity to address the issues. What follows is a discussion of several influential factors in China's macroeconomy, the continued development of which will affect both environmental protection and the environmental industry.

WTO Accession, Trade, and Investment

China's central planners are acutely aware of the effects WTO accession is having on the domestic economy, the pressures placed on Chinese enterprises, and thus the need to reform certain regulatory and institutional systems to increase efficiency in economic development. Already a number of changes are being seen, and they will increase and intensify in the coming years, partially as a result of regulations imposed upon the country by the WTO itself and partially as a result of the pressures imposed upon domestic enterprises by the presence of highly competitive foreign enterprises operating in China with fewer restrictions than ever before.

Some of these changes may benefit foreign enterprises by leveling the playing field and breaking down barriers established to protect less-competitive domestic enterprises. Others, however, benefit domestic enterprises as much as foreign ones. Ultimately, the government expects WTO membership to rationalize the country's international trading apparatus and foster highly competitive Chinese enterprises.

The most significant changes anticipated within a decade of accession will be
Regulatory Transparency

The Ministry of Foreign Trade and Economic Cooperation (MOFTEC) has established a new agency specifically intended to clarify all rules and regulations associated with WTO entry and foreign trade laws and regulations. All foreign trade activities are governed by formally published laws and regulations. Any internal laws and regulations that have not been formally published will be void. The MOFTEC has made clear its intentions to overhaul regulations to bring them more in line with international standards and has mandated that any measures formulated and implemented by local authorities must be consistent with national laws and reported to MOFTEC. All foreign business laws and regulations are available to the public, and drafts of certain laws are available for review and consultation in the formulation phase. Generally, this is in keeping with the commitments China made leading up to WTO accession. WTO entry is catalyzing transparency of laws and regulations as well as the development of a rules-based system, thus ensuring some level of predictability and gradually improving the climate for foreign trade and investment.

Other issues of regulatory transparency could remain troublesome in China for some time to come, though. As a rule, the country keeps information on what it classifies as state secrets and matters of national security under tight wraps. The law defines these in a vague and broad manner. Foreign investors in environmental industries have reported serious problems with such issues in the past. Initiatives have been stalled and in some cases terminated for infractions of laws that have not been made available to the public. It is also not unheard of for such laws to be used as an excuse to stall an initiative even though the true issue of contention is entirely unrelated.

Development and Rationalization of the Financial Sector

The Tenth Five Year Plan calls for a dramatic overhaul of the entire Chinese financial sector. Again, as a result of WTO accession, Chinese administrations are attempting to bring domestic financial institutions up to international standards. The central bank - People's Bank of China - and the China Securities Regulatory Commission (CSRC) are raising standards in both the banking system and the securities markets, to ensure the viability of the financial sector and increase international investor confidence. Several key components, such as an efficient and reliable credit rating system, are still lacking entirely. Other components are in need of further development and strengthening.

Banks. In November 2000, the National Bureau of Statistics reported that risks borne by the four state commercial banks had increased by 65 percent over the past eight years, resulting in a drop in their capital adequacy ratios to an average of 5.51 percent in 1999 (the internationally accepted critical rate of adequacy is 8 percent). Based on an unpublished internal rating index, risk assessments in the financial sector as a whole have risen by nearly 12 percent since 1991.

Administratively, political interference in commercial banking operations remains a stumbling block, and the independent and efficient promulgation of regulations is lacking. Meanwhile, competition within the banking sector is on the rise, placing increased performance pressures on the commercial banks. Two years after WTO accession, foreign banks will be allowed to make local currency loans to Chinese companies. Five years after accession, they will have unlimited access to the consumer market.

There is adequate awareness within the pertinent administrations regarding the concerns and threats the banking system faces. Administrative changes are underway, but some analysts question how efficiently reforms can be carried out. The People's Bank of China is developing an index system to detect and evaluate financial risks. It will monitor operations within the banks, security markets, and other fundamental macro-economic indicators.

Stock Markets. China's stock markets are somewhat chaotic, thriving more on rumor and manipulation than on market-oriented standards. Regulations and qualifications for listing in the markets are strict, keeping many companies off the boards. Meanwhile, the stock exchange is partially used to fund ailing SOEs through public offerings, and investors often buy in believing that the government will not allow a listed SOE to go bankrupt. The Zhengzhou Baiwen Company nearly proved them wrong in late 2000 when speculation arose that the massive retailer would be allowed to go under, but instead the SOE was bailed out once again, only enforcing the belief. Regulators reportedly feared that allowing Baiwen to go bankrupt would decimate investor confidence and possibly drain financial support from the 1,000-plus listed companies. In April 2001, China's first delisting finally occurred, marking the demise of the Shanghai Narcissus Electric Appliance Company. The event was accompanied by warnings of possible future delistings of similarly troubled enterprises, as well as widespread accolades for a sound step toward the modernization of the Chinese economy.

Prior to the Narcissus event, government-supported investor confidence led China's A-shares market to rank as the world's second best performing market in terms of growth in 2000. There is much indication that changes will arise, making future stock market growth more quality based in coming years. If faithfully implemented, the initiatives listed below should increase competition, creating stronger links between stock prices and profits and thereby shifting capital to the stronger companies:

Bond Markets. Currently, SDPC examines the issuance of all corporate bonds and sets limits on their volume. Each year less than $1.2 billion worth of corporate bonds are floated, as compared with $48 billion in treasury bonds. The CSRC controls the interest rates of both types of bonds. Corporate bond interest rates are routinely set below those for treasury bonds.

SOE Reform

In 1998, Premier Zhu Rongji set a goal to turn around loss-making SOEs within three years. While the time schedule has been relaxed somewhat, SOE reform policies since then have focused on enterprise restructuring, downsizing, and adjusting product output mixes. The government has also been focusing on a small number of what it calls "key" enterprises and major industries while deconstructing small and medium-sized SOEs and encouraging non-state capital to enter more sectors. During the Tenth Five Year Plan, reform will continue. The State Economic and Trade Commission (SETC) is expected to consolidate the state-owned sector into 50 to 100 giant SOEs.

By the end of 2000, proclamations of attaining Zhu Rongji's goal were numerous, even though the government was calling them questionable. The SETC proclaimed that 520 of the country's best-performing SOEs registered profits upward of $25 billion in the first 11 months of the year. However, a closer analysis indicates that 9 of the 14 major industries accounted for 93.6 percent of the total earnings and that petroleum and telecom alone accounted for 50 percent. One hundred fifty-eight of the 520 key SOEs registered 95.6 percent of the profits, and the top ten performing SOEs accounted for 74.2 percent of the total profits.

A number of factors such as high international oil prices, reduced debt burden as a result of debt-to-equity swaps, increased exports, and a number of IPOs on foreign exchanges are partially responsible for the profits. Varying degrees of sustainability among these and other factors indicate that a lot of work has yet to be done if the SOEs are to gain true overall profitability.

The Private Sector

Income tax payments from private enterprises in Beijing increased 110 times over the past six years, with their contribution to overall business income tax revenue in the municipality increasing from 0.3 percent in 1994 to 15.7 percent in 2000.

There remains little doubt that regulatory authorities recognize the importance of the private sector and are quietly condoning its support. The SETC is taking on the role of promoting the private sector's development, and drafting guidelines. The government has also expressed a desire for the private sector to participate in the western development plan, and the Ministry of Construction has indicated that the tightly controlled urban utility sector is gradually opening to private enterprise investment as well.

Nonetheless, a host of barriers continue to hinder the sector. It is extremely difficult for private enterprises to access funding from either banks or securities markets. Private enterprises, like foreign-invested enterprises, are restricted to certain sectors. State owned and private enterprises are not treated equally in regard to registration, taxation, government services, international trade, and access to financing. (For a detailed analysis of China's private sector, see the International Finance Corporation's "China's Emerging Private Enterprises," available online at www.ifc.org/publications.)

Selected References and Web Sites

Asian Development Bank. Country Economic Review: People's Republic of China. (Manila: Asian Development Bank, October 2000. Available online at www.adb.org/china/default.asp.) October 2000.

Bhattasali, Deepak, and Masahiro Kawai, "Implications of China's Accession to the World Trade Organization." (Paper presented at a conference sponsored by the German Institute for Japanese Studies and the Fujitsu Research Institute, Tokyo, January 18-19, 2001.)

Cao Dong and Sun Rongqing. Environmental Financing in China: A Review. CRAES/SEPA working paper presented at a conference sponsored by the OECD Center for Cooperation with Non-Members, Environment Policy Committee, November 2000.

CIA Directorate. China's Economy: 1995-97. December 1997. www.cia.gov/cia/di/products/china_economy/.

International Finance Corporation. China's Emerging Private Enterprises: Prospects for the New Century. September 2000. www.ifc.org/publications/.

Wang Jinnan, Wu Shunze, and Luo Hong. Integrating Economic Development and Environmental Protection in China During the 10th Five-Year Plan Period. Beijing: CRAES. November 2000.

Web Sites



South China Morning Post:

U.S.-China Business Council:

U.S. Department of Commerce:
www.doc.gov, www.usatrade.gov

U.S. Department of Commerce, Office of Environmental Technologies Industries:

U.S. Embassy, Beijing:

U.S. Embassy, Beijing. Country Commercial Guide: China:

World Bank Group in China:

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