Beijing's BYO To The Party

Beijing has unveiled a 4 trillion yuan (HK$4.54 trillion / US$582bn) economic stimulus package to help boost domestic demand - in what is seen as a shift to "proactive" fiscal and "moderately easing" monetary policies.

The measures, which run until the end of 2010, were announced after a meeting of the State Council chaired by Premier Wen Jiabao, Xinhua News Agency reported. Some 100 billion yuan (US$12.8bn) is earmarked for this quarter alone.

The spending will focus on 10 areas, including low-cost housing, infrastructure in rural areas, and social welfare, in addition to transport networks - railways, highways and airports - environmental protection and technical innovation.

It also includes capital expenditure to renew city power grids. Some of the spending overlaps longer-term stimulus plans reported earlier - including a 2 trillion yuan railway plan and 5 trillion yuan expenditure on roads, waterways and ports from 2006 to 2020.

BNP Paribas chief economist Chen Xingdong said: "This is the first time China has officially confirmed the shift to easing monetary and fiscal policies. Although it was a 'slow heating up process,' it shows the government's realization of the urgency to bolster economic growth." Economists have been anxiously waiting for a huge stimulus plan ever since gross domestic product growth slowed to 9 percent in the third quarter from 10.4 percent in the first half.

"At the Central Economic Work Conference, to be held later this month, Chinese leaders are expected to announce concrete measures to stimulate the economy ... Beijing's new policy drive of upgrading infrastructure, rural land reforms, and expansion of social welfare is akin to a 'New Deal' with Chinese characteristics," said Jing Ulrich, chairman of China equities at JPMorgan. China's economy grew at the slowest pace in five years in the three months through September as export orders shrank amid the global financial turmoil. Domestic industrial production also fell after Beijing ordered heavily polluting factories to shut down ahead of the Olympic Games in August.

The Cabinet also confirmed that reform of the value-added tax system will cut companies' tax bills by 120 billion yuan. Beijing will also remove credit limits of commercial banks to further encourage lending support to small and medium-sized enterprises. The People's Bank of China has cut interest rates three times since mid- September. People's Bank of China governor Zhou Xiaochuan, meanwhile, said the central bank forecasts the mainland economy to expand between 8 and 9 percent next year.

The success of this plan depends crucially on continued government credibility in the face of rapidly rising deficits as well as on the health and stability of the banking system.If the banking system can withstand a downturn without any significant rise in NPLs and without forced credit contraction, this may be the shot in the arm China and the world needs. This move by China is a very big hint of how worried the government is and how determined they are to address the issue that this plan was approved.

The government can force credit expansion by requiring the banks to lend more.

Certainly they are trying. Last week, after weeks of rumors that loan caps were being relaxed, the PBoC announced that they were junking the credit restrictions they had previously imposed on banks. But loan growth has still been very low.

This is hardly surprising. In such dire economic circumstances with global credit markets and liquidity seizing up, with domestic bankruptcies rising, with inventories and receivables also rising, it takes both brave banks and brave borrowers to accommodate credit expansion. Most good companies seem reluctant to borrow and anyway banks are reluctant to lend.

So what if policy-makers simply announce minimum loan growth targets for every bank? That should certainly cause an expansion in banks’ balance sheets. However, this will create some problems. It might not be effective in net credit creation for the country. If banks don’t want to lend but are forced to, we will see off-balance sheet transactions placed back on balance sheet and a much more rapid decline in loans from informal banks. That means that real credit expansion can still be negative even with minimum loan growth target enforced onto the banking system. Forced lending will also result in a sharp deterioration in quality of borrowers. It is always possible to find borrowers, even in a sharp economic contraction or investment crisis.

US$582bn is not a small sum, even if you spread it out over a few years. There is the multiplier effect or trickle down effects. The rule of thumb is that every one dollar spent is worth between 4-8 dollars in the real economy, velocity of money supply.

The sum announced by China is certainly very big. Is it big enough? The US GDP is about US$14 trillion or 3.5x China's GDP of US$4 trillion. Say US loses 2% of its GDP, to make it up, China would have to grow by a staggering 6.8% - of course, that's assuming the problem is just contained in the US, and that China is the only engine of growth left in the world. The other factor to bear in mind is that Chinese consumer only make up some 35% of China's GDP, much lower than US consumers. Final conclusion - its not a Prozac, but its better than nothing, a lot also depends on whether its for "show and tell" or will the measures be implemented assiduously.

p/s photos: Sammi Cheng