China shifts fiscal policy into neutral
By Chen Yao (China Business Weekly)
Updated: 2004-06-17 14:24

China's seven-year-old expansionary fiscal policy recently ended abruptly as top policy-makers began drafting a sharp revision to combat domestic inflation.

Finance Minister Jin Renqing remarked earlier this month that a "neutral fiscal policy will replace the proactive measures, and will better fit the macroeconomy's general conditions."

In March, Jin, in his annual budget proposed to the National People's Congress, pledged the government will strive to ensure the continuity of the expansionary fiscal policy.

The transition of China's fiscal policies, however, has been hailed by economists, who argue the overheating economy will only be cooled when the central bank's monetary policy and the government's fiscal policy are co-ordinated.

The People's Bank of China (PBOC), the nation's central bank, recently took steps to soak up excess liquidity.

The bank raised commercial lenders' reserve requirements and tightened control over bank loans to overheated sectors -- including steel, aluminium, real estate and auto.

Although there have been signs the growth of industrial production and money supply have slowed, policy-makers remain concerned the economy will land hard if inflation is not brought under control.

Official figures released last week showed growth in production and M2 -- the broadest measure of China's money supply --had slowed to 17.5 per cent from 19.1 per cent in April.

Production growth had slowed from 23.2 per cent in February and the increase in M2 was the smallest since December 2002.

Earlier figures had indicated China's fixed investments in the year's first four months was 42.8 per cent higher compared with a year ago.

That suggested the economy, in terms of investments, was still overheating.

This, as expected, has stoked fears the government's spending on infrastructure construction and massive projects will fuel the abnormally fast economic expansion.

Chinese Premier Wen Jiabao has vowed to reduce the country's economic growth to 7 per cent this year, from a seven-year high of 9.1 per cent last year.

China's investment boom has caused energy shortages, clogged transportation and pushed up prices of raw materials.

Power shortages affected 24 of the country's 32 provinces and municipalities in the year's first four months, the State Electricity Regulatory Commission said last week.

Abandoning the proactive fiscal policy will make it easier for PBOC to manoeuvre, and will ease pressure on the central bank to raise interest rates.

PBOC officials are vowing to raise China's benchmark lending rate if the consumer price index (CPI) growth surpasses the one-year lending rate -- currently standing at 5.31 per cent.

Although PBOC is maintaining the benchmark lending rate at a stable level, the yield of government bonds continues to rise.

The yield of the benchmark seven-year government bond, which matures in November 2010, has risen above 4.7 per cent. The yield was 3.4 per cent at the end of last year.

Many economists argue an interest rate hike would do more harm to the economy than the ongoing inflation, as higher interest rates would dampen investor enthusiasm in sectors that are not overheating.

That would weigh on consumer demand.

China's top policy-makers saw an exit for the expansionary fiscal policy as soon as the nation's economic locomotive was being manoeuvred back onto the fast lane.

China embarked on a proactive fiscal policy in 1998 to offset the negative effects of the Asian financial crisis, Jin said.

He noted the policy helped China shake off the threat of deflation.

Now, as the threat of deflation is

receding, there is no reason for the government to maintain its expansionary fiscal policy.

The "neutral" fiscal policy brought forward by Jin, however, will most likely result in the government readjusting the spending structure rather than curtailing overall spending, economists said.