Effects of Economic DownTurn On China's Economy

Part 1 - Effects of the economic downturn on China's economy:

1. Overview:

The development of China economy is quite unique if compare with the western countries. Before 1979, although there have been 3 worldwide technology revolutions and 3 major economic crises in the world, the relative impact to China was limited, mainly due to the less communication and cooperation between China and other countries.

Changes started from 1979, when China realized the gap with western countries and announced the "open door" policy. Along with the implementation of this new policy, China started to accelerate the economic development in the recent 3 decades, take part in the globalization proactively and play an important role in the global market.

So, other than in the old times, nowadays, the world economic fluctuation gives huge impact to China and it becomes critical for China authorities to think about how to face such impacts, how to better position ourselves, what solutions to take and whether any opportunity we will have.

Base on above facts, our analysis will focus on the ongoing Financial Crisis and its' relative impact to China.

2. The latest Financial Crisis and its' impact to China

- Impact path

As an outcome of globalization, economies worldwide are now increasingly entangled with each other, and it is impossible for a single economy to stay intact amid the global economic recession that originated from the U.S. financial crisis.

The so-called global financial "Tsunami" started from year 2007; originally occurred in the US, due to the subprime mortgage crisis, the financial system in the US was seriously influenced, and the impact spread to the whole western world and started to affect the real economy with global demands decreasing. As China is now playing a role as the manufacturing center for the world, this ongoing crisis is taking a heavy toll on China with weakening exports, reduced investments and credit flows that have dried to a trickle. In short, due to the manufacturer capacity redundant, the employment rate is also going down in China market, which caused the consumer confidence going down, and the further consumption decrease and GDP down, the following graphs shows the trend of China GDP and the consumer price inflation which are self explained.

The figure shows that with the real exports decreasing, China's real GDP growth will slow down from 13% in 2007 and 9% in 2008 to just 5.9% this year, followed by an uptick to 7.7% in 2010.

Meanwhile, the CPI index also shows a sharp decrease from year 2007 to 2008 which also reflects the impact of crisis on the consumer market.

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**Data from "IHS Global Insight".

And, following are the key aspects we would like to analyze in depth:

- Direct impact: Capital impact with the depreciation of foreign investment reserve.

China is now holding the foreign exchange reserve with total amount at 1.8 trillion US dollar, with the following conformation:

* Subprime debt - More than 200 billion US dollar, which is now almost worthless.

* Mortgage bond issued by "Freddie Mac" & "Fannie Mae" - around 370 billion US dollar, now only worth around 5% the value.

* Short term debt - another 300 billion US dollar, only worth about 5% as well

So, to make a simple calculation base on above loss, according to the current market value, China already had a huge loss on the foreign exchange reserve with total amount at 840 billion US dollar, which equals to RMB5.8 trillion. How huge is this figure? As I checked the total financial income for China in year 2007 is 5.13 trillion RMB, which means the current loss is even more than the financial income 2007.

- Indirect impacts on 3 aspects: These are the impacts to the real economy in China

* Exports impact - Declining overseas demand causes export decrease

Although the capital market in China is not fully opened, the China economy has high dependency to world market and the ratio is as high as 60%; and the top two business partners for China are EU and US. Now, facing the rapid downgrading of global demand, the impact to China exports is obvious.

One of the characteristics of China economy is that the export pushes domestic investment; and thus to push the growing of GDP. And now, with the decrease of export, the investment on fixed assets will also decrease. Although it seems that there are still a lot of potentials in the domestic market, and stimulate the domestic demand will be an effective method, it really needs time and may not be a short cut for the business recovery. As mentioned earlier, the position of current China is still at the bottom of the supply chain for global market, we act as the worldwide producer, and some figures indicated the elasticity of China economy vs western countries is still big, meaning that in case of small scale of business increase in western countries will bring large scale of business increase in China; and vice versa. And, to upgrade our position in the worldwide supply chain and adjust the industrial structure take time, it's impossible to be done overnight.

Here are some figures.

Since 2009, the foreign trades in China eastern, central and western areas are all declining.

i. Significant trading decline in the eastern region. In early 2009, China's top seven provinces and cities in the eastern area suffered dramatic fall in the import and export trade, including Guangdong, Jiangsu and Shanghai, their imports and exports fell 31.1%, 29.5% and 32.2% respectively.

ii. Significant shrinking on exports from resource-based provinces and cities in central and western. In January 2009, export of Shanxi province dropped 49%, 10 provinces out of total 12 in the western region have declines in exports, average drop at 35%.

iii. Increasing pressure on the export-oriented companies. Now, in the coastal areas, especially in Zhejiang and Guangdong provinces,