Cablegate: China Announces Stimulus Plan Ahead of G-20 Summit

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TAGS: EFIN ECON KPAO PREL PGOV CH
SUBJECT: CHINA ANNOUNCES STIMULUS PLAN AHEAD OF G-20 SUMMIT

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1. (SBU) Summary: In advance of the G-20 summit China's
leadership on Sunday took the unusual step of endorsing a
long-anticipated stimulus package before its annual
economic work conference later this month. The plan
emphasizes infrastructure spending, but also includes
targeted tax reductions, income support, and monetary
easing. The announcement estimated the "stimulus package"
will amount to RMB4 trillion (around USD600 billion or over
6+% of GDP) over the next two years, and RMB100 billion by
the end of this year. Until more details are available it
is impossible to determine how much of the announced
spending is additional to what already would occurred. Tax
cuts for business and monetary loosening are unlikely to
spur investment given the deteriorating economic outlook
and companies' excess capacity, and the continued high
household precautionary savings. The government, however,
appears committed to using fiscal spending to support the
economy. Even if they maintain spending growth plans from
previous years, it should still have a stimulatory impact
on Chinese domestic demand and investment. End summary.

An Unusual Announcement
-----------------------

2. (SBU) China's State Council on Sunday released a
statement announcing general principles that will guide its
economic policies moving forward. The announcement,
several weeks before the annual high level economic work
conference, showed the leadership's concern about slowing
economic growth and interest in getting a statement out
before the upcoming G-20 summit. Business surveys showed
rapidly deteriorating sentiment, and although the Chinese
government has not released its October economic indicators,
economists that have seen the data say they will show
marked slowdowns in all areas of the economy.

3. (SBU) The announcement was short on details, like most
State Council documents, but provides approval and guidance
for the operational ministries to implement programs that
fit within these guidelines. The ten approved areas (see
Annex A) primarily emphasize infrastructure spending, but
also include targeted tax reductions, income support, and
looser monetary policy.

"Active" Fiscal "Easy" Monetary
-------------------------------

4. (SBU) The State Council endorsed a "pro-active" fiscal
policy for the first time since 1998-2004. The statement
estimated the Chinese government will inject RMB 4 trillion
into the economy: around RMB 100 billion worth of stimulus
will occur this quarter, with the remainder operationalized
in 2009 and 2010.

5. (SBU) Beijing will adopt a "moderately easy" monetary
policy. In recent weeks the Central bank has lowered
lending rates and reserve requirements, and removed loan
quotas. Most observers expect additional rate cuts in the
coming months.

Chinese Economists' Reactions
-----------------------------

6. (SBU) Chinese economists without exception reacted
positively to the announcement. Asia Development Bank
chief economist Zhuang Jian and Development Research
Council Macroeconomic Research Office Director Zhang Liqun
hailed the stimulus package. Qinghua University Professor
Yuan Gangming felt the measures would "effectively boost
confidence" and were "released just in time," remarking
positively on the wisdom of loosening monetary policy to
support fiscal measures. This focus on consumer confidence
was echoed by Beijing University professor Cai Zhizhou.
Most Chinese economists are still calling for growth around
8 percent next year.

7. (SBU) Tax Research Institute Policy Research Office
director Zhang Peisen and Chinese Academy of Social
Sciences researcher Zhang Bin both emphasized the

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importance of VAT reform to boosting domestic demand.
Zhang Bin also praised the plan to build affordable housing,
which would stimulate demand while helping ordinary people.
However, Chairman of the Leading Group on Finance and
Economics Liu He (who leads preparation of the annual work
conference) had doubts that cutting the VAT for businesses
(by rebating VAT paid on purchases of capital goods) would
spur investment given overcapacity and the deteriorating
outlook.

Bang or Whimper?
----------------

8. (SBU) The RMB2 trillion per annum should make up about
6-7% of estimated 2009-10 GDP. In the last two years, the
central government's infrastructure spending accounted for
about 3% of GDP, with local-level spending making up around
8% (or RMB3 trillion total, with roughly 40% of spending
occurring in the 4th quarter).

9. (SBU) Absent additional details, it is impossible to
discern how much of the announced spending is additional to
what would have occurred. Based on conservative estimates
of nominal GDP growth and the long-term trend of an
increase in the ratio of government spending to GDP,
overall government spending would have been expected to
increase about RMB 2 trillion next year.

10. (SBU) However, much local infrastructure spending has
been funded by property sales and state-controlled
enterprises, so a slowdown in the property and corporate
investment would have made it difficult to finance
investments levels of recent years. Thus, part of the RMB
4 trillion could make up for shortfalls in local government
investment.

11. (SBU) Given banks unwillingness to lend to small- and
medium-sized enterprises due to increased credit risks, and
large enterprises' lack of credit demand, due to excess
capacity, looser monetary policy is not expected to boost
domestic demand significantly in the short-term absent
significant moral suasion on state banks and enterprises.
While the government has pressed state-owned banks to keep
enterprises afloat during previous cyclical downturns,
which led to a subsequent large accumulations of non-
performing loans, bankers we have spoken with in the last
several days (including CCB Chairman Guo, SDB President
Newman, and GDB President Zink) note that the market-
oriented corporate governance reforms since the last
downturn will make moral suasion less effective, and the
government appears to be focusing more on providing tax
breaks and subsidies to borrowers.

Comment
-------

12. (SBU) Premier Wen Jiabao noted during financial crisis
that "confidence is more precious than gold" -- a large
sentiment-boosting announcement in advance of the G-20 may
be aimed at shoring up domestic sentiment.

13. (SBU) The Beijing leadership, however, is also
committed to using government spending to stimulate the
economy through infrastructure spending. In addition, even
if the announced "stimulus" is largely a compilation of
already planned spending increases, the government is
committing to this in the context of a sharp fall in the
growth of revenues (which rose only 10% year-on-year in the
third quarter compared to 33% in 2007 and the first half of
2008). Given China's abundant savings, liquid banks and
low government debt ratio, the central government is in a
good position to use fiscal measures to contribute to
domestic consumption and investment. Regarding timing, the
government has already developed plans to improve
transportation networks, build lower-income housing, and
address China's water and pollution problems; many of
these programs were delayed in the last couple of years
while China focused on preparing for the Olympics, and
Beijing could accelerate implementation without much
trouble.

14. (SBU) However, until details of the recently announced

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spending package are released, and particularly the full
accounting of the mix of central government verses local
and state-owned enterprise spending, and the amount of
additional spending, it will remain impossible to determine
the economic impact of the package.

Ten Areas for Fiscal Stimulus
-----------------------------

15. (U) Annex A:

-- Housing: build more affordable and low-rent housing;
speed slum clearance; expand a pilot program to rebuild
rural housing; encourage nomad settlement.

-- Rural infrastructure: speed rural infrastructure
construction; improve rural road and power grids; spread
the use of methane; ensure drinking water safety; expedite
the North-South water diversion project; reinforce at-risk
reservoirs; strengthen large-scale irrigation; poverty
relief projects.

-- Transportation: accelerate transport network expansion,
including passenger rail links and coal routes; extend
trunk railways; build airports in western areas; upgrade
urban power grids.

-- Health and education: improve the local-level medical
system; accelerate junior high school construction in rural
western and central areas; build special education and
cultural facilities.

-- Environment: enhance construction of sewage treatment
and rubbish facilities; accelerate green belt and forest
planting programs; increase support for energy conservation
and pollution-control projects.

-- Industry: support innovation, industrial restructuring,
and the development of the high-tech and service industries.

-- Disaster rebuilding: speed reconstruction in the areas
hit by the May 12 earthquake.

-- Incomes: raise next year's minimum grain purchase and
farm subsidies; increase subsidies for low-income urban
residents; increasing corporate pension funds and
allowances.

-- Taxes: extending VAT reform to all industries (estimated
impact will be to reduce corporate tax burden by RMB 120
billion, USD17.6 billion); encourage technological
upgrading.

-- Finance: remove loan quotas; appropriately expand bank
credit for priority projects, rural spending, smaller
enterprises, technical innovations and industrial
rationalization.

Measures Adopted to Date
------------------------

16. (U) Annex B:

-- Raised tax rebates by 2% for certain textile and garment
exports. (August 1)

-- Raised the credit quota by 5 percent for national
commercial banks and 10 percent for local commercial banks.
(August 5)

-- Cut interest rates for one-year loans by 27bps to 7.2%.
(September 16)

-- Cut the reserve requirement ratio for all but the five
largest banks by 1% to 16.5%. (September 25)

-- Removed the stamp tax on stock purchases; allowed SOEs
to repurchase stocks; and began purchasing bank stocks.
(September 19)

-- Launched a margin financing and securities lending plan.
(October 5)

BEIJING 00004178 004 OF 004

-- Allowed non-financial enterprises to float mid-term
bonds. (October 6)

-- Cut deposit and lending rates 27bps. (October 8)

-- Cut the reserve-requirement ratio 0.5%. (October 15)

-- Increased house-purchase tax exemptions, lowered
mortgage interest rates, and lowered down payment
requirements. (October 27)

-- Cut benchmark interest rates by 27bps. (October 30)

-- Raised tax rebates for labor-intensive export items such
as textiles, toys, garments, and high-tech products.
(November 1)

RANDT

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