Financial Crisis

Global financial crisis which began in August 2007 has affected economies
around the world, some to a greater extent than others. The crisis started in
the US housing and financial markets, but it was soon converted into a global
one, hitting the four-fifths of humanity in developing countries (Watkins and
Montjourides, 2009).  The economic crisis
has spread to developing countries through trade linkages, a decline in Foreign
Direct Investments and remittances, and a large decrease in commodity prices.
Global financial crisis moderately impacted the Chinese stock exchange and but
it badly affected China’s exports markets. Yongding Yu (2010) considered four
major channels via which the global economic crisis impacted on the Chinese
economy: (1) direct losses in the American capital market; (2) changes in
cross-border capital flows; (3) reduction in growth of exports; (4) safety of
foreign exchange reserves.


was one of very few countries to escape the world economic crisis and experienced
only a mild slowdown in economic activity without a recession. Experts point
out that the economic crisis in America has had no major impact on China. Also
it has been estimated that China was less affected by the financial meltdown
than other countries, due to its more closed financial system.


major driving forces of China’s economy, The gradual liberalization of trade
which started in the 1980 with different reforms resulted in incredible growth
of the economy in terms of GDP, trade and foreign investment. So Foreign Trade
and Foreign Direct Investment (FDI) in China have been one of the major success
stories of the last couple decades.  **
The global economic crisis had impacts on Chinese economy mainly through the
contraction of FDI and trade channel. It was decline in China’s inward FDI
because the US and European Union economies suffered from the global recession,
as a result international capital has been pulled out of the China’s market and
has gone back to their home countries. Also there were sharp decline of
external demand and after it productivity of foreign invested enterprises
(FIEs) has started to decrease. As a result China’s suffered exports sharply
decline its GDP in the fourth quarter of 2008 and the first half of 2009
however China’s financial sector less affected by the economic crisis than
other countries, due to its more closed financial system, the relatively strict
capital control, and limited financial losses.


 Between 2001 and 2007 (before the global
economic crisis) the world economy had been grew steadily. The major economies
of the world, including those of the 36 United States, the EU and Japan,
registered healthy annual growth rates of 2% or more (World Bank, 2001-2007
statistics). By the first quarter of 2009, annual growth rates were negative.
The global financial crisis changed the growth trajectories of all major world






1: Annual
growth rates of

IMF Statistics, 2000-2008


global financial crisis there has been a great improvement in China’s economic
strength, particularly with a five consecutive years of economic growth rate of
over 10% from 2003 to 2007.  Also in
2007, China?s financial income reached 5.1 trillion Yuan and achieved fiscal
surplus of 0.28% of GDP. This proved that China’s risk-resistance ability was stronger
than ever. 45




of non-liberalized capital account, the fast growing Chinese economy has lost
the growth momentum due to the sharp contraction in external demand. The
collapse of external demand since the eruption of the global financial crisis
was threatening the sustainability of China’s export-led growth strategy
because this strategy has integrated the Chinese economy with the rest of the
world. External demand contributed more than 40% to the annual growth of the
Chinese economy from 2003- 2007. So it’s obvious that China’s GDP growth
suffered a sharp slowdown as a result of the global financial crisis, largely
due to a decline in foreign demand for Chinese imports. 52 It has been
estimated that the fall in exports will have cut China’s GDP growth in 2008 by
more than 5 percentage points. 53 As exports accounts for more than a third of
China’s economic growth and 10% of overall GDP, and the US is the second
largest recipient of all Chinese exports, a gloomy US economy might trigger a
“turning point” for China’s rapid economic growth. China’s central banks
estimates that if the US?s GDP growth declines by 1 percentage point, Chinese
exports to the US will drop by 6%, cutting about 2% from the Chinese GDP
growth. 54 United States, European Union, and Japan play an important role in
terms of purchasing goods produced by China. By 2002, just after China joined
the WTO, United States, European Union, and Japan had become China’s three
largest export destinations. Together they accounted for 54 percent of China’s
total exports at that time. By 2008, and the emergence of the recent financial
crisis, the share of the Triad in China’s exports had fallen further to 46
percent. So we can say that negative growth in China’s major trading partners
is the main reason for the steep drop in Chinese exports. 55








economists believe that China could face a recession if its growth rate were to
slow down to 5–6 per cent. The IMF (2009) and the World Bank (2009) predict
that in 2009, given the shock of the global economic crisis, the Chinese
economy will maintain a growth rate of between 6.5 and 7.5 percent. However
because of very large government tax revenues and foreign exchange reserves,
China was able to put in place a huge stimulus package that resulted in a
growth rate of 8.7 per cent in 2009. Much higher than what was forecast for
most economies of the world, and high enough to generate new jobs for millions
of laid-off workers and young

graduates. 46



only has China established its economy during this economic crisis, it has also

to the recovery from economic recession of other countries. The importance of
China?s role in coping with the economic crisis is widely shared by economists
at home and abroad. 47

GRAPH  2: China?s GDP Growth Rate Year-on-Year on
a quarterly basis, 2008-2011, (%)




















China’s Capital Control


(Renminbi’s) exchange rate

the Chinese currency, had been a non-convertible currency for more than 50
years until quite recently. China’s road toward convertibility has involved a
number of important reforms which have been implemented in a step-by-step
manner. Since the economic reform started in 1979, the Chinese currency (Yuan)
had been devalued several times until 1994. While the official rate of Yuan had
been maintained constant over seven years since 1998, the pressure on the
revaluation of Yuan intensified. It has been perceived by some economists that
the Yuan is

on an order of 15 to 35%. 59
2003 China’s RMB exchange rate became the focus of attention at home and
abroad. After years of speculation, China announced its change in exchange rate
system from the dollar peg system into a managed floating exchange rate system
“with reference to” a currency basket on July 21, 2005 and revalued the Yuan by
2.1% in July 2005 (PBC, 2006).


PBC has halted the Yuan?s gradual revaluation in July 2008 to 6.83 CNY/USD plus
or minus 0.3% and it has kept accumulating dollar?denominated assets to prevent
the Yuan from appreciating. In times of financial turmoil, Chinese leaders
prefer exchange rate stability, a policy pursued also during the years
following the Asian financial crisis. This makes the flotation of the Chinese
currency and the lifting of capital controls extremely unlikely in the medium
term. 60
is the only country which maintained a perfect fixed exchange rate with a peg to the US
dollar until 2005 and then adopted a crawling peg. Since 2005, the RMB has
appreciated more than 25 per cent in nominal terms, and about 50 per cent in real terms,
according to The Economist (The Economist, 4 November 2010), due to higher
inflation in tradable in China than in the United States. In response to the growing
imbalances between the two countries in the first half of the 2000s, Chinese authorities
allowed the RMB to appreciate steadily against the dollar from the middle of 2005 until
mid-2008. From July 21, 2005, to July 21, 2008, the dollar-RMB exchange rate
went from 8.11 to 6.83, an appreciation of 18.7% (People’s Bank of China data,
the outbreak of the global economic crisis of 2008, China’s exports fell sharply; China
then slowed down the pace of RMB appreciation in order to increase exports.
Meanwhile, Chinese leaders may have been afraid that RMB appreciation would also
seriously drive down the value of China’s vast foreign exchange reserves. As such, the
issue of RMB appreciation seems to have a profound and far-reaching impact on
China’s foreign trade, internal and external balances, foreign-exchange reserves,
etc. 61



foreign exchange reserves during the last decades

exchange rate policies such as attempting to slow (and sometimes halt) the
appreciation of the RMB against the dollar make Chinese exports less expensive
and foreign imports into China more expensive than would occur if China
maintained a floating currency. The main purpose of this policy is to promote China’s
export industries and encourage foreign investment.

of the most prominent political explanations of the accumulation of dollar
reserves by China and other developing countries was in fact developed by three
economists: Dooley, Folkerts-Landau, and Garber. They argued that these
countries’ policies were driven by their goal to promote rapid export-oriented
industrialization. In order to boost the competitiveness of their countries?
firms, governments maintained undervalued exchange rates by accumulating
foreign exchange reserves.

reserves were then strategically recycled into U.S. assets in order to help
keep their major foreign market economically healthy enough to continue
purchasing their exports. These economists drew a parallel to the reserve
accumulation of many Western European countries and Japan during the 1960s
under the Bretton Woods exchange rate system. 73 Before the crisis, China’s
reserves stood at over $1.5 trillion, of which approximately 70%–80% was in
dollar-denominated assets. 74 China’s economic policies, including those that
induce high levels of domestic savings and promote export-related activities as
the main engine of China’s economic growth, have contributed to a surge in
China’s FX reserves over the past decade, as indicated in Since China’s opened
its door to global economy, it have been started to accumulate rapidly foreign
exchange reserves in a result of large merchandise trade surpluses, inflows of
foreign direct investment into China, and inflows of “hot money” into China.



its current account surplus in excess of 0.5 percent of global GDP since 2005,
China developed large surpluses in current, capital and financial accounts for
many years. Thereby it has accumulated foreign reserves in excess of the total
reserves held by all other industrial countries combined. 75 As shown in
Graph 3.11 merchandise trade surpluses, large-scale foreign investment, and
large purchases of foreign currencies to maintain its exchange rate with the
dollar and other currencies have enabled China to accumulate the world’s
largest foreign exchange reserves at $3.312,0 trillion in the 2012, making it
the world’s largest holder of such reserves.



China’s Banking


with fragile Wall Street giants making huge losses due to the US credit crunch,
performance of the Chinese banks was encouraging. The restrictions on overseas’
portfolios investment buffered these banks from the global economic crisis.
China’s banking system escaped direct damage of the economic turmoil.


are some different features of Chinese commercial banks operation:


Chinese banks require much higher down payments than the US banks. In order to
reduce the operational risk to a controllable level, the Chinese Banking Regulation
Commission CBRC) requires at least 30% of the total value of the property as
deposit, while 100% mortgages were available in the US and the UK. 86


largest share of personal loans, typically at 70-80%. However, multiplied by
the ratio of personal loans to total loans, even in the state-owned banks, home
mortgages only accounts for 15% of their total lending. Therefore, the impact of
a house market downturn on Chinese banks will be limited. 87






banks in China have continued to remain as the main conduit of financial
intermediation within the country, until recently handling 80% or more of financial
flows in the country, with four major state-owned banks (SOBs) controlling 70%
of deposits and advances in the banking industry. Thus the security sector in China
remained at a nascent stage and no Chinese bank was permitted to invest in securities.
Despite having access to the market for securities, the state-owned enterprises
(SOEs) relied on banks rather than the stock market for finance. 88


foreign investors cannot trade in China’s stock market except through several
designated means such as the Qualified Foreign Institutional Investors (QFII).


Chinese government still exerts tight control over its currency policy. For instance,
there are restrictions on capital accounts; the Chinese currency, the RMB or Yuan,
is not fully convertible yet; the exchange rate is set in a managed floating


currently, foreign institutions can only own up to 20 percent of the equity of
a Chinese bank, and the total ownership of foreign equity investors is
restricted to 25 percent. The assets of foreign-funded banks accounted for only
2.44 percent of the total bank assets in China. This implies that even if
foreign banks tightened up lending due to financial difficulties of their
parent companies, it would not have substantially reduced credit flows in
China. 89


the Chinese Government has recapitalized and restructured the state-owned commercial
banks since the late 1990s and has attempted to reduce the immense
nonperforming loans (NPLs). The NPL ratio has fallen from over 30 percent at
the end of 2001 to only 1.77 percent as of June 2009 (CBRC, 2009).























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