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China and the Global Financial Crisis

Gunjan Singh is Research Assistant at the Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile
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  • December 04, 2008

    The global financial crisis which had been brewing for some time began to unfold in the middle of 2008. Stock markets around the world have nosedived, large financial institutions have collapsed or been bought out, and governments of even the wealthiest nations have had to come up with rescue packages to rescue their financial systems. The crisis stemmed from the collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialised economies. There are concerns that the global financial meltdown will affect the livelihoods of almost everyone in this globalized world.

    An indication of the scale and intensity of this crisis was the summit meeting of the Group of 20 held at Washington DC on November 15, 2008. These 20 countries together account for 90 per cent of the global economy. The summit outlined a series of steps to end the global financial crisis. Another summit has been planned for April 2009 to finalise the policies. Policies proposed at the summit include tighter financial regulation, greater transparency of markets, and an end to excessive salaries for top executives, though it will be up to individual governments to implement their own schemes.

    That the United States called a meeting of this larger group comprising several key developing countries instead of limiting consultations with the G 7 was also a manifestation of the growing relevance of developing countries in preventing a complete melt down and in turning the international economy around. Though President Nicolas Sarkozy proposed the idea of a G 20 meeting, and President Bush agreed to play host, the most sought-after country at the summit was China. With close to $2 trillion in foreign exchange reserves and an economy that is still growing, though at a slower pace than before the crisis, China is one of the few countries with the financial wherewithal to come to the aid of others in distress, either directly or by contributing to the coffers of the International Monetary Fund and thus enabling the latter to provide more emergency loans.

    Given its relatively closed financial system, China’s exposure to the global financial storm has been limited. However, its reliance on exports to Western markets has meant that it has not been completely immune to the financial crisis either. The Chinese government has been watching with anxiety as its exports growth has slowed to the lowest rate in the last five years. There has also been a rise in the number of protests fuelled by the increase in the number of factory closures. It is not yet clear whether in the face of the decline in demand from the American and European markets China would be able to sustain its high growth rate and thus cushion the adverse effects of the financial crisis.

    To overcome the adverse fallout from the global crisis, the Chinese government announced a US $586 billion national stimulus package in early November 2008. The primary aim of the package is to encourage growth in domestic consumption. Its focus is on encouraging growth and domestic consumption by encouraging investments in infrastructure, environmental protection and disaster rebuilding. The package targets the cement, iron and steel industries. It also aims to increase the flow the credit for major products. But the hope that such infusions of money into the economy will help increase domestic consumption can prove to be a little far-fetched. It has been seen that Chinese society is not consumption oriented but rather has a tendency to save. And this propensity towards savings might actually intensify in the face of the global financial crisis.

    A worrying possibility is that a significant reduction in economic growth rate would push more Chinese people below the poverty line. Slower growth would also mean lesser availability of resources to invest in the social security needs of the poor and the needy, especially given the larger imperative of cushioning the effects of the crisis on investments and on the banking system to prevent a complete melt down.

    Comparisons have been drawn between the present crisis and the 1997 Asian financial crisis to argue that just like China managed to maintain its high rate of growth in the wake of the earlier crisis it will be able to do so this time as well. But this contention ignores the fact of China’s dependence for its exports on Europe and America, which are now in recession. The Chinese currency, while rising modestly against the dollar, has strengthened sharply against the currencies of its Asian competitors and against most European currencies. This has made its exports far less competitive in these markets. The stimulus package could provide a breather but it is not clear whether China will be able to weather the storm.

    Slower economic growth is also likely to have an effect on internal political stability, given that the communist party’s legitimacy is today underpinned by rapid economic growth. A slow down and the resultant adverse impact on a wide cross-section of Chinese society could lead to mass protests and the questioning of the party’s legitimacy and right to rule. The internal situation could become quite unmanageable for the communist party if the disenchantment in Tibet and Xinjiang flares up again.

    Thus, contrary to expectations, China may not be able to play a crucial role in helping the world economy get back on its feet.