Feb 8, 2021 in Economics

Financial Crisis and its Impact on China

The world economy has faced the global financial crisis that is considered being the most severe crisis since the 1929-33 depression. Financial factors were the major contributors to outburst and spread of the ongoing crisis. In 2008, more than twenty U.S. commercial banks went bankrupt, and five most important investment banks were closed down or restructured. Similarly, in Europe, numerous financial institutions appeared to be in distress. The financial crisis has pushed all the leading economies in recession and triggered the collapse of the stock market.

At present, the economy of China takes one of the leading positions on the market worldwide. Thanks to its rapid growth, China has been transformed from an inconsiderable player on the world market to the leader in terms of exports, with significant imports volumes. In particular, China exports data processing equipment, medical and optical equipment, iron and steel, as well as consumer goods; whereas it imports metal ores, organic chemicals, mineral fuels, plastics, electrical machinery. Based on the market exchange rates, from 1978 to 2010, the Chinas GDP share in the world economy has risen from 1.7 % to 9.5%. It has become the second largest economy leaving the Japan behind and, according to Li, Willett and Zhang, it is only the matter of time before it surpasses the United States. Thus, this essay is aimed at investigating the course and the influence of the financial crisis on the Chinese market, and analyzing the measures of the Chinese government to support the economy during the crisis, including prospects of the economys development after the crisis.

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The Reasons behind the Financial Crisis

According to Overholt, one of the core reasons of the global financial crisis is the liquidity provoked by the Chinas inexpensive exports and Chinese foreign exchange reserves. Additionally, the author blames the currency regime of China for global imbalances. Because of large amounts of Chinas exports, the global prices for consumers goods have decreased. Inexpensive Chinese products have kept US and European inflation down. As we know, when the excess liquidity overwhelms an economy and the inflation for goods is on its top, the prices of stock and real estate assets rise. Thus, the exceptional rate of liquidity leads to the exceptional increase of asset prices. This resulted in the subsequent asset bubbles with the acceleration of financial peculation and speculation.

In turn, Chinese leaders and analysts such as Li, Willett, Zhang, and Gang mainly reject the responsibility of China in the global crisis, while arguing that the bubbles and the results of the collapse was caused by the credit crunch provoked by the U.S. and European failures. These include poor regulation and supervision of the bank system and mortgage institutions, as well as mismanagement of the credit procedures that led to the corruption in the system. The financial institutions of different countries that had invested in securities listed on the real estate market of the USA, suffered immense losses.

Nevertheless, it is an undeniable fact that the rapid growth of the Chinas GDP has changed the development of economic activities throughout the world leading to the excess liquidity. From 1999 through 2010, the Chinas share of world exports has increased from 3% to 10%. Furthermore, Chinese imports, which include components and parts that will be further incorporated into the exports of China, have made a major impact on the commodity prices across the world. Therefore, China is considered a significant assembly center for the global trade. However, it is noteworthy that a major promotion of exporting the Chinese products is created and maintained by multinational corporations rather than Chinese firms alone. Thus, the excess of Chinese liquidity and Western failure in its regulation may be considered as the core reasons of the global financial crisis.

Influence of the Crisis on the Chinese Market

Not only China has influenced the world economy, and hence the global crisis, but also the global crisis has made its severe influence on China. According to Li, Willett, and Zhang, economic interdependence is a two-way street. Before the crisis, China stock market went through a boom, having increased fivefold thru 2005-2007. However, when the USA and Europe began to fall into recession, the decreased demand in their economies made a crucial impact on the Chinas economy.

In 2007, the Chinas stock market and the real estate market crashed. While being exposed to changes in global demand and real estate industry, from October to November 2008, export growth rate of China fell from nearly 20% to 2 % because the consumers of the advanced countries had to lower their demand for products, in particular those imported from China. Consequently, in 2009, the overall Chinas exports decreased by almost 17%.

Concerning the consumption, the rate of the total retail sales of goods increased by nearly 20% in the beginning of 2008. However, in the fourth quarter of 2008, the decline of the economy was already apparent, whereby the rates of imports, as well as exports, were immensely decreased. In 2008, CPI was appreciated by 5.9%. Most of all, the crisis has damaged private and service sector, as well as small and medium industries. Numerous large private enterprises went bankrupt, whereby 20 million of unskilled workers from rural areas lost their jobs. The drastic decrease in growth rate took place in such industries as electricity and steel production, as well as transportation / vehicles.

The collapse of the western demand has significantly aggravated the Chinese domestic issues such as rise of currency and wages and effects of inflation. The mismanagement of RBMs exchange rate was one of the core factors that strengthened the internal and external imbalances of the Chinese economy. The problem worsened with the decline of the external demand and banks intervention in the U.S. exchange market.

Although during the crisis, China was strongly affected by the global financial crisis, it was still able to maintain its relatively high growth rate during the crisis. While representing 9.6% of economic growth in 2008 and 9.2% in 2009, China continued to remain one of the most rapidly growing economies across the globe. Therefore, at first glance it may seem that China does not refer to the countries immensely hit by the financial crisis. However, the rate of the Chinas growth has substantially dropped as compared to its 14.2% growth increment demonstrated in 2007. Therefore, the negative impact of the financial crisis on China should not be underestimated.Nevertheless, China was able to preserve and recover its economy during the years of the financial crisis. According to Li, Willett, and Zhang, the main reasons of such ability imply the policies provided by the Chinese government.

The Policy of the Chinese Government

One of the most significant reasons of Chinas success is a well-developed stimulus package, as well as the governments ability to adopt it already in November 2008. While representing a combination of fiscal and monetary policies for 2008 and 2009, the RMB 4 trillion ($580 billion) stimulus package was aimed to support the economy during the crisis. This package has provided a stimulus for bank lending, as well as a crucial support for commodities prices.

The concern about recent inflation was effaced by monetary tightening that influenced the commodity prices, as well. The Central Bank of China has cut the deposit interest rates several times to 2.52 percent. Moreover, it abolished some strict restraining rules and conditions for bank reserves and enabled the increases of lending opportunities. According to the official statistics represented by Overholt, in 2009, the fixed asset investment was up 33.5% over 2008, and the real estate investment rose 14.7% over its 2008 index. However, because of the alarm concerned with the asset bubbles, by July 2009, China began to apply the monetary brakes and thus slowed the amount of lending. Thus, the Chinese government has reached a relative balance for its crisis policies.

For example, evidently, from the end of 2008, the Chinese government loosened the regulation and control of the property sector. The percentage of the loan interests for buying a home has been reduced. Consequently, the terms for getting a loan were loosened, the developers could be easily financed reducing the chance to drive down the prices of the property.

To finance the stimulus package, the banks of China accumulated foreign exchange reserves worth nearly 3 trillion dollars, including U.S. treasury bonds. Hereby, China showed to be immune to the capital outflows that resulted from the crisis manipulations of investors. This has become possible because during the beginning of the crisis China has immensely decreased FDI. Thus, from 2008 to 2009, the net FDI of China dropped from 121.68 billion to 70.32 billion dollars. After the crisis, it has recovered its net FDI to 124.93 billion dollars, in 2010.

When the global financial crisis hit the country, the Chinas government has provided a decisive response to it in order to mitigate its negative impact as soon as possible. Li, Willett, and Zhang state that major financing for the growth and development of Chinas economy comes from the domestic sources rather than exports. Thus, in 2008, the foreign-funded banks represented the total assets of 193 billion dollars that equal just about 2.4 % of all Chinas bank assets. This percent is too small to make a significant impact on the national financial system. Therefore, to spare the efficiency costs, China reduced its control over the flow of international capital. Additionally, the household savings were a sound base for providing funds to recover the Chinas economy. In 2008, the saving deposits of residents amounted 22.2 trillion RMB. Hereby, the consumer loans balance was just 3.7 trillion. Ultimately, Bank of China, Industrial and Commercial Bank of China, Bank of Communications accumulated almost 250 billion RMB while making public offerings; hence, the financial balance sheet was in a very good shape.

The Chinese central government enforced and incited the local governments to implement the projects as quickly as possible without posing any serious regulatory or legal obstacles. Thanks to combined and reinforced fiscal policies and regulations, the Chinas monetary stimulus focused on bailing out the existing financial system, which had a substantial and immediate economic impact. Government was involved in the realization of the actual projects, as well. Major funds were utilized in Chinas property and stock markets, thus contributing to their partial recovery. In 2010, the budget deficit of the central government of China made only 1.7% of GDP, in contrast to 8.9% in the USA.

The sectoral data provided additional evidence of the revival of Chinese economy. In 2009, while being enhanced by stimulus programs, China outmatched the United States with selling cars for the full year rising 48% over the index of car sales in 2008. The Chinese government began to issue subsidies for the acquisition of appliances and electronics that resulted in the 15 % growth of domestic retail spending. Hence, the GDP growth rate was increased from 6.1% to 7.9% just during the second quarter of 2009.

Influence of the Crisis on the Chinese Market

When the economies of the USA and the European countries began to recover in 2010, China began to yield the positive exports growth, as well. As for 2010, with the GDP growth rate of about 10%, China has outperformed all other developed economies. In 2010, China passed Germany to become the top exporter of the world with exports at nearly 1.5 trillion US dollars while the United States ranked third on the list. Hereby, the Chinas imports worth nearly 1.3 trillion US dollars took the third position in the world. Despite a certain softening of the Chinas economy in 2011, it has high potential for development. However, the economists argue that if China and Western countries will not address their problem of liquidity and mismanagement, the next crisis will be even more influential and severe that the crisis of 2007-2009.

The governments efforts were successful in stimulating the current economic activities, as well as activities in the short-term perspective. However, some structural adjustments, which were cancelled to mitigate the crisis influence and stimulate short-term growth of the economy, are essential for the long-term development of the Chinese economy. At the strategic level, the Chinas government has to contribute to the development of the economy focusing on a new path while denying such strategies as using cheap labor force and making overinvestment in heavy industry. The Chinese government should invest in the development of its own market as the domestic market can help China preserve its sustainability in growth during the global changes.

In resolving an unemployment issue, the government should not rely solely on supporting export growth. Alternatively, the employment can be promoted by developing and maintaining the service sector. Because this sector is also labor intensive, it has a potential to provide the workers from the export sector with job. To attract respective investments, the Chinese government has still to adjust the RMSs exchange rate mechanism and the mechanism of foreign exchange reserves.

The global financial crisis is both an issue and a valuable opportunity for the Chinese economy. Although it has significantly influenced Chinas exports, foreign exchange reserves, and employment, it also stimulates China to make structural adjustments in order to expand its investments. Such adjustments should involve the choice of household consumptions as a top priority, and, hence, focus on the household income rather than corporate and government income. Hereby, the government has to reduce the personal income tax while providing more fiscal resources directed towards the provision with social security, education, and health care that can reduce the uncertainties about future welfare.

Results

The paper has analyzed a decline in the economy of China as a result of the global financial crisis. Chine is an essential part of the world economy; however, the countrys economy decreased its growth rate at the end of 2008, as well as was hit by other severe crisis effects. The government of China was focused on maintaining the continuation of the economic growth and controlling the excessive deviations of growth indexes. Information on how China has preserved its relatively high growth rate during the years of the financial crisis may be crucial for investigators and policy makers, who are interested in strategies for decreasing or eliminating the consequences of the possible future financial crises. For ensuring of its further success, China has to focus on the development of the domestic market, expansion of small and medium business, and high value-added manufacturing.

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