China’s economic stimulus programBUSI 3001 SBLCWeek 2(3), Spring 2015

Charles Mo & CompanyMarch16, 2015

China Stimulus Program of 2008 and Investments in China November 9, 2008 stimulus program

Why did the Chinese need a stimulus program while its economy was still growing?

Global financial crisis started from a US liquidity crisis extended worldwide and led to China’s decision to a stimulus program

Comparison between the US Stimulus Program and that of the Chinese Components of the Chinese stimulus program Did the Chinese stimulus program work?

Chinese GDP rebounded Export recovered

Foreign investments in China Foreign firms facing issues from Chinese media and regulators

Chinese investments overseas CIC (China Investment Corp)

Reasons for the Chinese Stimulus Program

Social stability is China’s priority Maintain the 8% GDP growth rate Export dependent which totaled 35% of the GDP in 2008 Maintain a low unemployment rate US global leadership – During the G 20 summit in 2008,

President Bush called the leaders of the largest economies for a global economic cooperation in continued free and open trade.

Chinese introduced the Stimulus Program

In 2008, the US financial crisis in the banking and financing system resulted in a severe liquidity strain which eventually affected the rest of the world and started the worst recession in the developed countries since the Great Depression.

After Lehman Brothers failed in September 2008, confidence in banks declined, credit risks soared, triggering the 3 month Libor (London Inter Bank Offer Rate) to reach 5%

By December 2008, all the world developed economies such as US, European Union, and Japan were in recession(except Australia).

In November, 2008 China announced the first stimulus program of $585 b to revive the economy.

Date Events Victim Bailout sponsor Cost in billion

   

January 22, 2008Feds cut interest rate by 75 percentage basis, largest since October, 1984 to 3.5%.  

 February 11, 2008 Bush Stimulus Package  167

March 16, 2008

Feds step in and intervened. JP Morgan Chase acquired Bear Stearns for $2 a share for 236 million Bear Stearns

JP Morgan and Treasury 67

   

March 18, 2008 Cut interest 75 base point to 2.25%  

   

July 14, 2008Announced to assist FREDDIE MAC and FANNIE MAE Federal Reserves  

   

September 7, 2008Treasury nationalized the two largest mortgage companies in the housing mortgage industry FREDDIE Treasury 15

   

 Treasury nationalized the two largest mortgage companies in the housing industry FANNIE Treasury

15

   

September 15, 2008 Bank of America to acquired Merrill Merrill Lynch Bank of America 50

   

September 15, 2008 185 year old Lehman Brothers filed for bankruptcy Lehman Brothers None 0

   

September 17, 2008 Treasury nationalized AIG AIG Treasury 85

 September 29 DOW dropped 700 points to 10371  

October 3, 2008 Emergency Economic Stabilization Act of 2008 Americans Congress 700

   

December 16, 2008 Interest rate cut to 0.25% Feds  

•Prime rate, federal funds rate, COFI Updated 3/11/2015

WSJ Prime Rate 3.25 3.25 3.25

Federal Discount Rate 0.75 0.75 0.75

Fed Funds Rate (Current target rate 0-0.25) 0.25 0.25 0.25

11th District Cost of Funds 0.698 0.692 0.768

By Bankrate.comThe prime rate, as reported by The Wall Street Journal's bank survey, is among the most widely used benchmark in setting home equity lines of credit and credit card rates. It is in turn based on the federal funds rate, which is set by the Federal Reserve. The COFI (11th District cost of funds index) is a widely used benchmark for adjustable-rate mortgages.

Read more: http://www.bankrate.com/rates/interest-rates/prime-rate.aspx#ixzz3URU7CRG6 Follow us: @Bankrate on Twitter | Bankrate on Facebook

Recession is the economy shrinking for two consecutive quarters (=6 months) with adecrease in the GDP (=Gross Domestic Product)

GDP = Value of all the reported goods and services produced by the people operating in the country

What is Recession?

GDP = MONEY VALUE OF {C + I + G + (X – M)}

C = Consumables, I = Gross Investments, G = Government Spending, X = Exports, M = Imports

Depression Long-term downturn in economic activity More severe downturn than a recession that is part of a normal

business cycle Considered a rare and extreme form of recession Elements of Depression

a depression is characterized by its length, and by abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly

devaluations. Price deflation, financial crisis and bank failures

1) a decline in real GDP exceeding 10%, or 2) a recession lasting 2 or more years.

Reaction from the Chinese business people on Global Financial Crisis Most business people in China ”didn’t imagine that

these events in the U.S. would affect them,” “For most of the last 18 years, the economy has been continually growing, so they’ve gotten used to continued economic growth.”

4 Trillion Yuan ($585 b) Stimulus Program Resulted in budget deficit - 3% of GDP

1998 1.1% deficit of GDP 1999 1.9% 2000 2.5%

18 months stimulus program Details of the program

How much comes from central government spending? How much comes from tax credits? Central government will contribute 1.18 trillion

2009 & 2010 600 billion each Rest from private sectors and local governments

Budget deficit 3% China GDP 2009

Fiscal policy aiding the economy Central bank cut key lending rate by a 108 basis

point November 24, 2008 Willingness to create budget deficit to stimulate the

economy Encouraged the banks to lend

Bank loans designed to spark economy Feb 13, 2009 - Chinese banks issued 1.62 trillion yuan ($237 billion) in new loans in

January, up 101 percent year-on-year. The massive jump in lending is equal to about one-third of the loans issued in the

whole of 2008, April 11 (Xinhua) -- Credit extended by China's banks in the first quarter hit 4.58

trillion yuan (670 billion U.S. dollars), the People's Bank of China (PBOC) In March alone, new yuan-denominated loans increased by 1.89 trillion yuan. It was

the third straight month that new loans exceeded 1 trillion yuan. June 19 (Caijing.com.cn) China's credit boom has increased bank lending by more

than 6 trillion yuan since December. Many analysts think an economic boom will follow in the second half 2009. They will be disappointed. Much of this lending has not been used to support tangible projects but, instead, has been channeled into asset markets.

The current surge in commodity prices, for example, is being fueled by China's demand for speculative inventory. Damage to the domestic economy is already significant.

Wsj06-10-09China’s stimulus program sparks surge in borrowing

Research Institute of Fiscal Science estimated the total local government debts amounting to 4 trillion RMB or 16.5% of GDP before the stimulus program

Total state debts estimated at 35% of GDP rather than the official 18%

Thus budget deficit may end up with 3-4% by the end of the year Hidden cost of local government borrowing is difficult to estimate

Reason is unreported government debt Some local government are paying off old debts with BJ stimulus funds

LIBOR = London Inter Bank Offer Rate

Boosting the economyBreakdown of China’s stimulus package

Total spending:4 trillion yuan ($585.76 billion)

45% 25% 9.25% 8.75% 7% 4% 1%

Railways. Highwaysairports, power grids

Post disasterreconstruction

RuralDevelopmentAnd infrastructureProjects

EcologyAndEnvironment

Housing Security

Independent Innovation

HealthCultureAnd education

The US and the China Stimulus Program

US 700 B & 785 B China 585 B

% of GDP 10.7% 20%

Government Spend per year

20% of GDP 20% of GDP

Tax Credit/reduction

1/3 or 295 B VAT on imports

Infrastructure 33% 45%

Healthcare 14% 1%

Budget deficit $1.7 trillion $139 b (950 b RMB)

Did the stimulus program work? GDP grew 10.4% in 2009 GDP grew 11.5% in Q1, 2010. 10.5% in Q2 Official inflation rate in 2010 was 2.8%

Housing property price increase 9.7% in August, 10.3% in July New home prices rose 11.7 percent in August compared with 12.9 percent in

July this year. (China Daily:9-13-2010) Per sq meter housing in SH average 14000 in 2008, now around 30000 Food price up 7.5% in August, 2010

Rice Is up by 50% Noodles up 50% Cooking oil up 50%

Export recovered Trade surpluse with trading countries resumed

China exiting stimulus program Lending and investment spending slowed in Feb, 2010 Economists urges BJ to unwind its stimulus measures because of

warnings about inflation pressures Fixed asset investment in urban areas rose 26.6% in January-

February, 2010 period from a year earlier compared with 30.5% in 2009 according to National Bureau of Statistics.

CPI rose 2.7% in February PBOC will gradually normalize monetary conditions $102.6 b new loans in February compared with 1.07 trillion last year

and 1.39 trillion in January

Issues Facing Foreign investments in China

Change of new leadership in 2013 and new direction for foreign invested companies in China

Some of the multinational companies affected Apple Inc Volkswagen AG Yum Brands Inc McDonald’s Walmart Coca-Cola

China business is significant for these companies Apple China grew 67% in sales to $6.83 billion and 49% to $2.54 billion for the

quarter ended December 29, 2012. China sales accounts for 12% of total Apple sales.

China accounts 28% of all Volkswagen sold in the world.

Issues Facing Foreign investments in China

Apple apologized and changed its warranty policies Volkswagen recalled 380,000 vehicles after the media complained

about overall qualities of the cars causing maintenance problems. Walmart and Coca-Cola went local to train their managers to handle

local domestic politics. In the past, these multinational companies rely on their executives to lead and handle consumer public relations.

China investments overseas China’s sovereign fund- CIC(China Investment Corp)

Created in 2007 Has a portfolio of $600 billion Return on investment 10.6% in 2012 and a loss of 4.3% in 2011 Invested $44 billion in oil, gas, natural gas assets in 2013, and $30 billion in

2012 North American headquarters located in Toronto, Canada

AES Corp

CIC purchased a Virginia based energy power provider AES Corp for $1.58 billion at $12.60 per share or 15% stake in 2010.

CIC sold 20 million shares back to AES at $12.90 reducing the 15% stake to 8.3% in December 2013.

Regulatory filing by AES indicated this buy back is normal invesment process in line with management strategy.

GEL-Poly Energy Purchased a 20% stake in GEL for $710 million in November

2009. GEL is a green energy supplier listed in Hong Kong. In January, 2013 sold 7.8% in GEL for $410 million. This is

the second sale bringing CIC stake to 4.6% and reaping a total of $689 million thus far.

New strategy for CIC

Due to tapering of US Federal Reserve planned decision to reduce treasury bond purchase, CIC believes the investment fund will flow back to the US or developed countries.

And China is changing its economic model to more consumption based than export dependant economy, making reliance on energy supplies less urgent than before.

CIC is focusing investment in rebounding economies such as the US and the European Union.

China’s Attempts to Invest in the US

2005, UNOCAL bid by (CNOOC) China_National_Offshore_Oil_Corporation

In 2008, Huawei bid for 3Com was called off due to regulatory restriction. September, 2013 Shuang Hui bought Smithfield, the largest provider for

pork in the US February, 2014, Gold Leaf Jewelry of China is to purchase ERG, an

energy provide in Texas and California for $665 million pending government approval.

July, 2012, CNOOC bought $15.1 billion worth of Nexen, a Canadian energy company.