Control Measures Old and New

Followingin the footsteps of the “parity deposit system” of 1949, indexation of bank deposits was reintroduced in the face of the near 20% inflation of 1988. The buying panic that developed in that year saw the public pull their funds out of the banks and use the proceeds to stock up on durable goods.

The time deposit increased rapidly in 1989 and 1990. By the end of 1989, the total deposit reached 514.69 billion yuan, which was 134.54 billion yuan higher than the year before... This trend continued in the early 1990s. At the end of 1991, the total residential deposits was 911 billion yuan, which was 46% of the gross national product (GNP) in that year (1985.5 billion).

the China Statistical Yearbook. Unadjusted figures are reported in Table 3.3 so as to at least achieve consistency across time.

⁹ The price index used to calculate the value of the SIR was an unpublished “Total Commod­ity Retail Price Index” that included retail commodities, service products, and producer goods (see Burdekin and Hu, 1999, for further details).

Indexed government bonds with a three-year maturity were also intro­duced in late 1988. These indexed bonds offered returns tied to the SIR and proved very popular. The value of indexed bond issuance was RMB 12.5 billion in 1988 followed by another RMB 12.2 billion in 1989, with a three-year maturity. By comparison, only RMB 5.6 billion of same-maturity non-indexed bonds, themselves offering an interest rate of 14%, were issued in 1989 (Burdekin and Hu, 1999). Had the SIR remained at peak 1989 lev­els, the indexed bonds would have yielded nominal returns as high as 26%. However, by the time the indexed bonds matured in 1991-1992, the infla­tion rate was below the three-year savings deposit rate of 8.28% and the SIR was zero.^[45]

The holders of the indexed bonds would have received only 9.28% in 1991-1992 (the 8.28% savings deposit rate plus 1%) had the authorities not retroactively hiked the payout to match the 14% coupon paid on the nominal bonds. This move was followed by renewed indexation of govern­ment bonds in 1993. Yet the outcome was quite different in that inflation was not controlled before the bonds matured and actual payouts did exceed 25%. The March 1996 SIR of 11.29%, for example, coupled with a base rate of 13.96%, yielded a total return of 25.25%. On April 1, 1996, the author­ities announced a permanent end to the indexation policy. Nevertheless, the indexed bond issues formed an integral part not only of the Chinese government’s anti-inflation program but also of the attempt to replace the prior system of “induced” bond subscriptions - whereby payments were deducted from salaries and operated like a withholding tax - with vol­untary purchases.

More drastic palliatives than indexation, however, had received serious consideration as the gradual removal of price controls was met by run­ups in commodity prices. Indeed, the Chinese Academy of Social Sciences’ own Research Group of Price Reform (1987, p. 139), called for: (1) the establishment of a price ceiling/protection price; (2) organizing a special (procurement) market for trading key commodities; (3) adjusting demand and supply indirectly via monetary and fiscal policy; and (4) using state trad­ing companies to stockpile commodities and release them onto the market. Although no such widespread intervention was actually implemented, the authorities have, at times, continued to resort to administrative measures of price control during the reform era.¹¹ For example, in the second half of 1995, the municipal government in Chongqing introduced a set of admin­istrative and economic controls aimed at reining in the city’s inflation rate (Shijie ribao [World Daily], 1996). Chongqing had had the worst inflation performance in 1994 of all the 35 largest cities in China. Focusing on basic foods, the municipal government increased their stocks of grain, oil, and meat and intervened aggressively to offset upward pressure on the mar­ket price of stocked meat. Although these measures were accompanied by resumption of a rationing system, the policy of unleashing a large supply of a key commodity (in this case, 500 metric tons of stocked meat) onto the market to drive down urban prices remains reminiscent of the 1949-1950 initiatives.^{[46] [47]}

Meanwhile, in 2005 China’s State Reserve Bureau - after copper prices spiked upward on rumors that one of their own traders had accumulated a huge short position - “tried to cool the market by announcing it would sell 20,000 tonnes of copper...

However, the Chinese authorities have, for the most part, had no need for such measures in recent years. Underlying domestic inflationary pres­sures have been greatly reduced by enhanced fiscal discipline since the early 1990s, and the People’s Bank has increasingly relied upon more conventional monetary policy tools like open market operations to stabilize prices. This major change from past practice has occurred in the aftermath of the 1994 Budget Law, which prohibits the government from borrowing from the Peo­ple’s Bank of China.^[49] As noted by the World Bank (1996, pp. 10-11), follow­ing the passage of this Budget Law, “1994 and 1995 saw a contraction in bor­rowing from the central bank and a shift toward commercial bank financing, and direct borrowing from the public (using treasury bonds.)” Monetary policy remained relatively tight even as the budget deficit expanded after the Asian financial crisis, when the government launched a fiscal stimu­lus program aimed at combatting slowing economic growth. Spending on pump-priming measures immediately jumped to $12 billion in 1998. Such higher government spending was itself a response to rising unemployment and weak consumer spending, with China’s growth rate declining from around 10% in 1995-1996 to 7.1% in 1999.

The (unadjusted) budget deficit’s share of the economy rose to 3% in 2002 before dropping back to 1.5% in 2004 and 1.2% in 2005. Neither this deficit level nor China’s debt-to-GDP ratio of around 25% would normally be considered worrisome in themselves. Both figures are considerably better than the norm for developing economies and better than recent US perfor­mance - not to mention Japan, with a debt-to-GDP ratio well above 100% and rising. Nevertheless, China’s official fiscal position excludes an array of large, and likely mounting, implicit government obligations. As Bergsten et al. (2006, p. 37) point out, these include debts incurred by provincial and subprovincial authorities and unfunded state pension liabilities. Moreover, while direct finance of loss-making state-owned enterprises has been reined in since the mid-1990s, the bad loans previously made to these enterprises remain as a huge potential future fiscal drain. Much of this bad debt, which was acquired by the asset management companies set up to relieve the balance sheets of the large state-owned banks in 1999, had still not been disposed of by 2007. The government is ultimately responsible for covering the difference between the relatively high price paid for this debt and the much lower yield actually received by the asset management companies (see Chapter 7).

In addition, the cost of government-funded bank recapitalizations in 1998, 2003, and 2005 together amounted to 20% to 24% of China’s 2004 GDP. The question is not whether more such infusions will be required in the future but rather just how much bigger they will need to be. There remain serious sources of current and future fiscal burdens not adequately reflected in the rather benign official budget deficit data for China. As discussed earlier, this was true in the past as well. Increased off-budget loans apparently played an important part in fueling rising fiscal pressures at the time of the 1988 and 1993 inflation jumps (World Bank, 1995). Such off- budget loans also seem to have been a factor in the pre-reform period with People’s Bank loans supplying 100% of working capital needs in the run-up to the 1961 inflation spike (Hsiao, 1971). Although the available data are insufficient to quantify a causal relationship between fiscal pressures and inflation in China, history does suggest that the potential for new fiscal strains should not be taken lightly.