The Hindu Business Line : All eyes on China’s stimulus package

With major economies expected to show negative growth in the coming quarters, the world may be looking up to China and India to contribute to the incremental growth of world GDP.

M. V. S. Santosh Kumar

Early this week, China announced an investment package of 4 trillion yuan ($586 billion) over a period of two years (up to 2010) to support its slowing economy.

Almost one-fifth the size of its GDP (gross domestic product), this package was earmarked to stimulate domestic demand. Before this move, the Bank of China had cut policy rate three times in the recent past. It had also cut export taxes recently. These measures provide credence to the shift in the Chinese monetary policy focus - from targeting inflation earlier to stimulating growth now.

Rationale

China had been growing at a higher pace not because of the domestic consumption but due to huge trade surpluses. But now, it is in an unenviable position as countries depending on Chinese goods are cutting down their consumption. This is bound to have a negative impact on its economic growth.

This package will fund various infrastructure projects, tax cuts for businesses, low cost housing and rural investment over the next two years. The country expects this spending to create employment opportunities and encourage domestic consumption.

The stimulus package comes at a good time for two reasons – one, inflation is heading downwards; and two,

with major economies expected to show negative growth in the coming quarters (due to the impact of the credit crisis), the world may be looking up to nations such as China and India to contribute to the incremental growth of world GDP. Last year, China contributed to 27 per cent growth in GDP.

In its latest report, the IMF has cut the GDP growth forecast for China for FY09 from 9.3 to 8.5 per cent. Having huge potential to grow in future, China does not want to postpone its growth because of the global credit crunch.

How is it funded?

Only 25 per cent of China’s stimulus package will be funded by the central government; the remaining would be funded by the respective provinces, state governments, banks and local bodies.

But there is not much clarity on how the fund will be used, as the plans envisaged are reported to be overlapping with various projects China has already taken up. For example, the funds required for rebuilding of the quake-hit Sichuan province may be clubbed with the stimulus package.

How markets reacted and why?

The day after the announcement of the package major commodities such as copper, aluminium, iron ore and crude oil went up on expectations that China’s industries will consume more raw materials; however it was a temporary euphoria as the prices reversed the very next day.

Major Asian bourses such as Japan, China, India, Taiwan, Singapore and Hong Kong surged following the announcement, but reversed as the exact effects of the package will only be known over time.

How is it likely to help the ailing global market?

Taiwan, South Korea and Japan which depend heavily on exports to China may primarily benefit from this move as the domestic infrastructure spending by China would require them to export raw materials and equipment etc.

The US and EU are also expected to benefit from this move as major equipment such as turbines and other machinery are provided by these countries. But effects of the package may be far-reaching and could mean more business for countries such as India, Australia and Brazil.

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