The Case of China

NOTE: This article was prepared for the Conference on Comparative Study of Financial Liberalization in Asia, East-West Center, September 22-23, 1999. It will be published in Financial Liberalization and the Economic Crisis in Asia, edited by Chung H. Lee, and published by RoutledgeCurzon, New York in 2003 as part of the “European Institute of Japanese Studies East Asian Economics and Business” Series.

By conventional measures China escaped the most adverse consequences of the Asian financial crisis. More than two full years after the onset of the crisis, China’s economic growth, while down somewhat compared with pre-crisis levels, remained the highest in the region. The value of the currency, the renminbi, remained fixed at 8.3 vis a vis the U.S. dollar and official foreign exchange reserves expanded by a further US$49.7 billion in the three year period ending December 1999. Foreign direct investment inflows reached a plateau in 1998 and then shrank by 12 percent in 1999. But even in 1999 inflows were US$40 billion, almost certainly the largest of any emerging market economy. Export growth moderated somewhat in 1998 and 1999 but, but unlike other countries in the region, China was able to sustain strong import growth and still maintain a significant positive trade surplus.

The central thesis of this paper is that China avoided the Asian financial crisis primarily because its financial system was relatively closed. Domestic financial liberalization had not yet begun, limiting China’s vulnerability to a currency crisis. Yet China remains vulnerable to a domestic banking crisis. Sustaining strong economic growth and avoiding a banking crisis will depend very much on skillful implementation of further financial and other economic reforms. This is because China’s pre-crisis financial fundamentals were in many ways considerably worse than other Asian countries drawn into the contagion; its fiscal position is fundamentally weaker; economic growth is decelerating; price deflation is deepening; the balance of payments, particularly the capital account, has deteriorated at a pace and for reasons that are not well understood; and political constraints inhibit the rapid closure and exit of large numbers of money-losing state-owned companies, compounding weakness in the financial sector.