2 Moderately Tight Fiscal Policy: 1993–1997

1. Background

2. The Moderately Tight Fiscal Policy Measures

3. Achievements of Moderately Tight Fiscal Policy

Between 1993 and 1997, the Chinese government implemented a moderately tight fiscal policy, or rather, a contractionary fiscal policy, to counter economic overheating and inflation. This had injected countercyclical vitality into the economy, achieving sustained economic growth. This marked a major shift in macro control from administrative commands to economic tools.

1. Background

In the early 1990s, as the economic reform progressed, the market began to play a more important role, which also boosted the reform in the price system. Having acquired greater autonomy in operation, SOEs were notably reinvigorated. As a result, China’s economy was ushered into a new period of rapid growth. China’s GDP increased 9.2% in 1991, and 14.2% in 1992. In the first quarter of 1993, it jumped by 14.3% and in June, the gross industrial outputs grew by 30.2%. Rapid expansion of investment demand and sharp surge in the price of production factors led to serious economic overheating and inflation. This was shown not only in the overheating in real estate, development zones, fund raising, and stocks, but also in the insufficient supply of transportation, energy, raw materials, and funds. Various sectors, especially the financial sector, were in chaos, and macroeconomic operations were confronted with more tension (Exhibit 2.1).

1.1 Oversupply of Money

Cash supply followed a pattern in China: a net cash withdrawal occurred normally in the first half of a year, and a net cash injection in the second half. In the 14 years from 1979 to 1992, a net cash withdrawal occurred in all the first halves of the years with the only exception of 1988 when there was a net cash injection of around 1.2 billion yuan in the first half of the year. In 1993, however, the pattern was reversed. The swift rise in capital construction investment generated tremendous demand for credit, so the central bank had to keep issuing currency, leading to money oversupply. By June 23, 1993, the net cash injection reached 58.5 billion yuan, and money in circulation jumped by 54.1% year-on-year. Being two months ahead of the normal cash injection time, this had far deviated from the normal practices. If this situation was allowed to continue, cash injection for the whole year would have gone far beyond the money target of 100 billion yuan, and very likely, this would have destabilized prices and stepped up inflation (Exhibits 2.2 and 2.3).

1.2 Overexpansion in Investment and Consumption

The year 1992 saw the establishment of 1,951 development zones, 14 times more than that of the previous four years. The number of real estate companies reached 12,400, double the figure of 1991. Luxury villas, office buildings, amusement parks, and vacation villages sprouted. The sharp increase in the development zones and real estate resulted in an excessively high growth in fixed asset investment. In the first half of 1993, the total fixed asset investment increased by 70.7%, the highest rate since the start of reform and opening-up, and 31.8 percentage points higher than the same period in the previous year. The investment made within just the first half of 1993 was 12.7 times that in 1958 and 1.4 times that of 1985, both years being regarded as years of expansive investment.

The number of new projects and the scale of investment increase were unprecedented in China. Projects of capital construction and

technological upgrading in the state sector totaled 22,161 in 1993, which was 3,059 more than that in 1992. The planned total investment was 125.7 billion yuan, 1.1 times more than that in 1992. By the end of June 1993, the accumulated investment in fixed assets under construction climbed to 1,493.4 billion yuan, an increase of 35% over that in the first half of 1992. At the same time, consumer demand also expanded excessively. From January to May 1993, the banks’ payments for wages and other cash payments to individuals increased by 36.4%, while spending on government and enterprises’ overheads increased by 89.4%, and the institutional purchasing power rose by 29.1%. All had far exceeded the economic growth rate, leading to a rapid increase in retail sales. During the first half of 1993, the total volume of retail sales grew by 24.4% over that in 1992. Month-by-month growth accelerated, from 15.2% in January and February, 22% in March, 30.9% in April, and 32% in May, to 34.9% in June. Due to the overexpansion of aggregate demand and lack of effective supply, the gap widened between aggregate demand and supply, rising to 10% in the first half of 1993 or four percentage points above the normal level (Exhibit 2.4).

1.3 Worsened Inflation

Inflation soared every month from September 1992 on. In January 1993, the consumer price index (CPI) shot up to 10.3%, and hit 14% in May. The price index of living costs in 35 large- and medium-sized cities rose by 19.5% over the same period of the previous year. During the first half of 1993, the CPI was up 13% in urban areas and 11.5% in rural areas. The main reason for the surge in prices was the overexpansion of investment demand, which caused a rapid price increase of the means of production. From January to May 1993, the purchase price index of raw materials, fuels, and energy increased by 31%, and the price index of the means of production shot up 43% over the same period of the previous year. As a result, the production costs of many enterprises rose considerably, and many construction projects had to bear mounting costs, resulting in price hikes of downstream products. Price indices of agricultural means of production rose 11.2%, which dampened the farmers’ enthusiasm for increasing agricultural input and hindered agricultural development. The 27.2% increase in service prices together with the sharp CPI rise added to the difficulties facing some employees and retirees. These were signs that the economy was experiencing a medium inflation; social stability and economic growth would be jeopardized if inflation continued to accelerate (Exhibit 2.5).

1.4 Financial Disorder

The boom of new projects and excessive investment exacerbated the illegal inter-bank lending and fundraising outside of the banking system that appeared in the second half of 1992. Large amount of funds was used for speculation in real estate, stocks, steel, and development zones. It was estimated that about 200 billion yuan circulated outside of the banking system, half of which was misappropriated by the state-owned commercial banks for illegal inter-bank lending. All these slowed the growth in residents’ savings deposits. From January to May 1993, residents’ savings increased by merely 91.2 billion yuan, 22.6 billion yuan less than that in 1992. In March 1993, the absolute value of residents’ savings even decreased. Irrational investment caused disturbance in lending, fund shortage for purchasing agricultural products in many places, and untimely settlement of exchange rate differentials in export. Besides, fund security could not be guaranteed even for the state’s key projects, post remittance settlements, and corporate working capital. Some grass-root banks faced difficulties in meeting clients’ demands for cash withdrawal. Sale of the Treasury bonds stagnated: only 1.84 billion yuan-worth of bonds were issued in the first five months of the year, a mere 5% of the planned figure.

1.5 Imbalanced Industrial Structure

Rapid industrial growth had exposed all the more clearly the bottlenecks in infrastructure and primary industries. Transportation, especially railway transportation, stretched to its limits, yet only met 30-40% of the demand. The supply-demand gap in the main production factors further enlarged, but could only be filled up through imports. In the first half of 1993, steel imports increased by 364%. Energies, such as electricity and oil products, were in severe shortage and power supply could only be provided for four days a week in some places. The overheating in real estate and development zones exacerbated the supply-demand conflict, and further elevated the prices of steel, cement, and timber. From January to May 1993, steel prices went up by 83.5%, cement 91.5%, and timber 67.2%. At the same time, agricultural development slowed down, which reduced farmers’ income growth. The per capita cash income of rural residents increased only 2% in the first half of 1993, seriously dampening the farmers’ enthusiasm for agricultural production and improving farming conditions. Driven by comparative benefits, farmers reduced the planting areas for spring crops, such as spring rice, spring wheat, cotton, and sugar plants, by 12.72 million mu, 5 million mu, 1.8 million mu, and 3 million mu respectively (15 mu= 1 Hectare). In the first six months, sales of agricultural production factors increased by only 2.1% over the same period of the previous year. After adjusting for inflation, the real sales decreased by more than 10%.

1.6 Increasing Fiscal Difficulties

Fiscal expenditure grew much faster than fiscal revenue, leading to an increasingly high deficit. In 1991, the fiscal deficit hit 5 billion yuan. In 1992 the budgeted deficit was four billion yuan, but the actual deficit expanded to 7.4 billion yuan, 3.4 billion yuan above the target. With increasing fiscal expenditure and declining revenue, the deficit continued to swell in 1993. From January to May, fiscal revenue was 129.6 billion yuan, down 2.2% from the same period of 1992, while fiscal expenditure increased by 15.9%, 18.1 percentage points higher than the increase of fiscal revenue. Meanwhile, disorder in tax collection, excessive tax reduction and exemption, and rampant tax evasion seriously disrupted normal fiscal operations. Funds for important sectors, such as energy and transportation, and the adjustment fund for the national budget, suffered from significant contraction (Exhibit 2.6).

1.7 Deficits in the Balance of Payments

With sluggish exports and accelerating imports, the foreign exchange reserve decreased. In 1993, an imbalance began to emerge in balance of payments when rapid economic growth, rising domestic prices lifted imports much higher than exports. From January to May, exports totaled US$30.2 billion, up 8.2% over the same period of 1992, and imports jumped to US$33.3 billion, up 26.9%, resulting in a trade deficit of US$3.1 billion. By June 10, 1993, China’s foreign exchange reserves had fallen to US$19.3 billion, US$5.6 billion less than that in June 1992. At the end of June, it dropped further to US$18.9 billion or US$1.2 billion lower than that in the beginning of 1993, a 25% drop from that in June 1992. If the trend continued, the trade deficit would grow further, and the foreign exchange reserves would fall short of the target US$20 billion (Exhibits 2.7 and 2.8).

All indicators pointed to an off-track, overheating economy. Without effective and timely macro control, serious imbalance between aggregate demand and supply and large economic volatility would arise.

2. The Moderately Tight Fiscal Policy Measures

The Chinese government paid a great deal of attention to economic issues and adopted proper measures to address them in good time. At the end of 1992, the government took actions to stabilize and strengthen agricultural production, curb illegal fundraising and inter-bank lending, regulate issuance of stocks and bonds, adjust bank interest rates, and tighten the supervision of development zones and the real estate sector. The Securities Commission of the State Council and the China Securities Regulatory Commission were established to strengthen stock market supervision. At the beginning of 1993, the government announced its intention to strengthen and improve macro control and prevent economic overheating. In April 1993, Circular of the State Council on Curbing Illegal Fundraising and Strengthening the Management of Bond Issuance was issued. In May 1993, Circular of the State Council Concerning the Strict Examination and Approval and Conscientious Checks on Various Development Zones was made public. On June 24, 1993, in light of the severe economic situation, the government made a resolute decision in Opinions of the State Council on the Current Economic Situation and Strengthening the Macro-Control, mapping out 16 measures to strengthen and improve macro control. The keynote for practicing moderately tight fiscal and monetary policies was thus officially established. On that basis, the Ministry of Finance (MOF) initiated a series of corresponding fiscal policy measures, aiming for a firm control of aggregate demand and economic restructuring.

2.1 Ensuring due Revenue through Strengthening Revenue Collection and Management

Efforts were made to strengthen tax collection and management to plug up tax loopholes, and ensure a fairly rapid revenue increase. First, more emphasis was placed on taxation according to law. While continuing to improve its collection and management of taxes payable by the state sector, the government also strengthened its tax collection and management of the non-state sector, the individual income regulating tax,¹ and individual income tax. Local governments were deprived of the power to initiate tax reduction and exemption, and the power to reduce or exempt contributions to the “two funds” (i.e., the Fund for Key Energy and Transport Projects

¹ The individual income regulating tax was introduced in 1986 to adjust income levels of lcoal residents.

and the State Budgetary Adjustment Fund). Local governments that failed to meet the target contribution of the “two funds” due to unauthorized tax reduction and exemption had to reduce their return shares of the two funds accordingly. Approval was suspended for temporary tax reduction and exemption for taxpayers experiencing difficulties in production, living, etc. Tax payment must resume upon the expiry of tax reduction and exemption. Fixed asset investment regulatory tax could not enjoy tax incentive schemes, nor could development zones that were not approved by the central government be covered by the tax incentive schemes. Local governments could not discretionarily require enterprises to commit a fixed amount of turnover tax. Tax management was strengthened over foreign-invested companies to prevent tax evasion by means of profit transfer. Reduction and exemption of duties and import industrial-commercial tax were reevaluated. The export tax rebate system was improved through linking export tax rebate with export exchange settlements. Special tax receipts, purchase invoices, export declaration forms, and exchange settlement sheets were strictly required for claiming tax rebates. Tax refunds were not to be given to those who did not comply with concerned rules and regulations. Second, efforts were stepped up to rectify tax management. Tax arrears were cleaned up to ensure that fiscal revenue was collected timely and fully. A focused nation-wide investigation was carried out on tax evasion, unauthorized tax reduction and exemption, and issues relating to the “two funds.” Revenue that was illegally retained was transferred to the central fiscal account. Third, the issuance of treasury bonds was required to be completed within a specified period of time. Residents were encouraged to subscribe for treasury bonds; banks and non-bank financial institutions were all required to play an active role in the underwriting. Balances of the pension and unemployment insurance funds were also used to buy treasury bonds. For each province, issuance of other planned securities was not allowed before treasury bonds had been fully subscribed.

2.2 Reining in Fiscal Deficit through Strengthening Budget Management

Reining in fiscal deficit was an integrated part of the moderately tight fiscal policy. The Chinese government required local fiscal budgets to be prepared in strict accordance with the Regulations on the Management of National Budget, and did not allow deficit. The areas with a budgeted deficit had to modify their budgets to ensure a balance throughout the year. In March 1994, the Second Plenary Session of the Eighth National People’s Congress (NPC) approved the Budget Law of the People’s Republic of China. The law stipulates that the central government shall not compile a current budget with deficit; and the local budgets at various levels shall be compiled in line with the principles of keeping expenditure within the limits of revenue and maintaining a balance between revenue and expenditure with no deficit. Beginning 1994, the central government’s fiscal deficit was offset mainly through issuing bonds, rather than through overdrafts or loan from the central bank, or rather, the People’s Bank of China (PBC). In March 1996, the NPC required that fiscal deficit should be gradually reduced to realize a basic fiscal balance during the Ninth Five-Year period (1996–2000). In practice, because of the strict control over fiscal spending, the increase in fiscal expenditure, which stood at 24.1% in 1993 and 24.8% in 1994, fell to 16.8% in 1995, 16.3% in 1996, and 16.3% in 1997. The central government deficit also shrank from 66.7 billion yuan in 1994 to 66.3 billion yuan in 1995 and 60.9 billion yuan in 1996.

2.3 Curbing Consumption Growth through Controlling Institutional Purchasing Power

In the second half of 1993, the Chinese government took measures to cut the number of conferences and strictly control their costs. Expenses for local and ministerial conferences were to be reduced by 20% from the budgeted figure. Activities such as overseas study tours, investment road shows, and festival celebrations were reduced. Enterprises had to implement regulations on performance-based salaries; exorbitant subsidies and allowances both in kind and cash were forbidden; and the increasing consumption fund was curbed.

Government bodies and non-government institutions were required to economize administrative expenses, the cost for office facilities had to be kept within budget, and additional budget in the name of office automation would not be approved. Strict examination and approval were required for eight commodities under special government control, and approval for purchasing cars and telecommunication devices by government bodies and institutions was suspended in the second half of 1994. Approval for purchasing commodities under special control was suspended for loss-making enterprises or those with tax arrears. In 1994, the government issued an order, calling for a rational guidance and control of consumption growth through the following measures: (i) preventing public funds from being spent on luxury items or for individual purposes; (ii) controlling wage raises lest individual income should rise at the loss of state assets; and (iii) banning allowance and bonus abuse. Moreover, the errant practice of some local governments—increasing the number of persons entitled to wage raises and inventing new allowances—was rectified. In 1995, additional efforts were made to curb the consumption fund growth, while any discretionary attempts to increase payroll, bonus, and allowance were stopped and rectified. To further contain the rising government spending, MOF brought institutional purchasing power under effective control through quota, special approval, statistical management, and supervision.

2.4 Restraining Fast-Growing Fixed Asset Investment through Cleaning up Capital Construction Projects

To cope with the sharp rise in capital construction investment, the Chinese government strengthened investment management in 1993. This was done through: (i) strictly controlling investment scale, sorting out projects under construction, and screening new projects; (ii) ceasing or delaying investment in luxury hotels, office buildings, and vacation villages, which failed to comply with industrial policies and lacked reliable financing and favorable market prospects; and (iii) requesting that new and large-scale construction projects could only start after the central government’s approval.

To control the funding source, the central government took a number of actions. First, it imposed mandatory planning control over bank loans for fixed asset investments to prevent enterprises from misappropriating current capital loans for fixed asset investment. Second, it reinforced the real estate market management, formulated policies on collecting real estate value-added tax (VAT), and banned speculative activities. Moreover, real estate developers were required to undertake at least 20% of low-profit residential housing projects. The government would recall the land purchased by a developer if its capital input into land development within the year was below 25% of the land procurement costs. Financial institutions and land administration departments were prohibited from establishing real estate development companies; those that had already done so had to divest themselves of the companies within a specified timeframe. Real estate developers who falsified information on registered capital, who were unqualified for real estate development, and who evaded taxes, were subject to strict investigation and punishment.

In January of 1994, the government issued Circular of the State Council on Continuing to Strengthen the Macro-Control over Fixed Assets Investment, calling for efforts in the following aspects: (i) concentrating resources on important projects, guaranteeing their completion or launch; (ii) exercising more prudence in examining and approving new projects so that, in principle, no new projects would be approved that year; (iii) strengthening control of funding sources for a better control of fixed asset investment; (iv) strengthening loan market regulation; (v) surveying and registering all projects under construction; (vi) strengthening management of the real estate sector and development zones, and refraining from approving new development zones in 1994; and (vii) upgrading the guidance and regulation of foreign direct investment (FDI). In 1995, strict control over fixed asset investment continued; in 1996, the project capital system for fixed asset investment was introduced.

2.5 Fostering Institutional Innovation through Expediting Reform of Fiscal Management System

To support the development of the socialist market economy, the Chinese government decided to adopt a tax-sharing fiscal system. First, based on the administrative jurisdiction of the central and local governments, it defined the scope of fiscal expenditure for governments at all levels. The central government would be responsible for national security, foreign affairs, and operational expenditures of central government agencies. In addition, it also covered social development expenditures under its direct management, economic restructuring, regional development coordination, and macro control. Local governments footed the bills for local government operations, and local economic and social development. Second, the division of revenues between the central and local governments was determined in a way that matched fiscal strength with administrative responsibility. Taxes necessary for the protection of national interests and execution of macro control were classified as central taxes. Some major taxes directly pertinent to economic development were to be shared by central and local governments. Taxes more suitable for local collection and management were grouped as local taxes with a view to raising local revenues. In the meantime, tax authorities were further improved for effective tax collection and management. Two institutions of tax authorities were set up, i.e. the central and local tax collectors. The central tax authorities collected central taxes and shared taxes, while the local tax authorities collected local taxes.

In addition, the system of inter-governmental transfer payments was established with focus on tax revenue return and general transfer payment. In order to ensure local governments’ vested fiscal interests and smooth operation of the new system, the base of tax revenue return from the central to local governments would increase yearly on the basis of the level of 1993. In 1995 transfer payments for the transitional period were implemented. The concepts of standard fiscal revenue and expenditure were introduced, and local governments would get transferred payments if their fiscal revenue could not meet the requirements of standard expenditure. The tax-sharing fiscal management system had basically straightened out the fiscal relations between the central and local governments. This heightened the enthusiasm of governments at various levels to manage fiscal resources, and established a primary mechanism for maintaining a steady growth in fiscal revenue. In the subsequent years, the proportion of central fiscal revenue in national fiscal revenue gradually increased, enhancing the central government’s capability for macro control.

2.6 Establishing a New Tax System and Improving Tax Policies

The central government established and improved the tax management mechanism by speeding up the revamping of the old system. In 1994, in the context of establishing a socialist market economic system, strengthening macro control, and further integrating into the global economy, the Chinese government initiated a comprehensive tax reform under the guideline of “unified tax law, fair tax burdens, simplified tax system, and rationalized division of authorities.” Drawing on international practices, the government restructured its turnover tax system, transforming the old one that varied its tax rates by products into a new one centered on VAT and complemented by consumption tax and business tax. The previous approach of determining the enterprise income tax by the forms of ownership was changed. The income taxes of SOEs, collective-owned enterprises (COEs), and private enterprises were merged into corporate income tax. The practice of setting a fixed income tax rate for SOEs was also revamped. The pre-tax deductible items and deduction standards were regulated. Preferential treatments, such as deducting loan repayment before tax and other requirements for charges, were abolished. The individual income regulating tax levied on Chinese citizens, the individual income tax on foreign citizens, and the income tax on urban and rural self-employed businessmen were all unified into a single individual income tax. Other taxes including the resources tax were also reformed and improved.

Through the tax reform, a tax system that conformed to the socialist market economy was established, and the regulatory function of tax policies highlighted. For instance, the VAT was reduced or exempted on agricultural products and agricultural production factors. Specifically, the VAT rate on agricultural products went down from 17% to 13%, and the VAT on six types of fertilizers, 15 pesticides, seeds, seedlings, and farming machines was exempted until the end of 1995.

2.7 Promoting Agricultural Development through Increasing Investment

The moderately tight fiscal policy meant a flexible structural adjustment rather than a full-range contraction. The central government controlled aggregates, containing the overexpansion of aggregate demand for a balance with the aggregate supply, through increasing revenues, cutting down on expenditures, and controlling deficit and the scale of debt, amongst other measures. At the same time, attention was paid to adjusting the expenditure structure and enhancing support for the weak sectors in the national economy, such as agriculture through additional investment and preferential policies. Since 1994, to guarantee the national grain reserves, stabilize agricultural product prices, and maintain farmers’ enthusiasm for production, the fiscal authorities had established a special national grain reserve fund, a grain risk fund, and a nonstaple food risk fund. Special funds were set up in support of the construction of planting bases for vegetables, grains, cotton, and edible oil. From June 1994, the grain purchasing price was raised, with the average purchasing prices for rice, wheat, corn, and soybeans increased to 0.52 yuan per kilogram. From September 1994, the cotton purchasing price was also lifted. Fiscal expenditures on policy-related price subsidies increased from 29.9 billion yuan in 1993 to 45.4 billion yuan in 1996. The agricultural policy projects with both economic and social benefits (such as anti-desertification and forestation) were encouraged through interest subsidies for bank loans. Through these measures, the fiscal policy’s support for agricultural development was strengthened. From 1994 through 1996, fiscal expenditures on agriculture increased by 16.7% or four percentage points higher than that between 1991 and 1993.

2.8 Promoting SOE Reform through Encouraging Technological Upgrading

From the second half of 1993, the central government took a series of measures to encourage enterprises to upgrade their technologies. They were allowed to accelerate depreciation based on government

regulations, list R&D expenditures in the cost without constraints, count interest on loans as asset values or financial costs, and determine the distribution of post-tax profit independently. The regulations on setting up special deposit accounts for special enterprise funds were abolished, allowing enterprises to control and use their own funds. Enterprises were also allowed to retain a fixed proportion of their profit as provisions for bad debts. In line with national policies on industrial development and science and technology, the central government also increased its appropriations or discount interest loans for corporate R&D and technological upgrading. At the same time, the government extended considerable support for optimizing enterprises’ capital structure, and replaced fiscal appropriations for SOEs with loans, with the balance turned

into state equity. In 1995, SOEs in 18 cities, where the pilot scheme was conducted to optimize SOEs’ capital structure, were permitted to replenish their equity by means of preferential income tax rate of 15%. The loan loss resulting from SOE mergers and bankruptcies could be offset by the provisions for bad debts within controlled aggregates. Those insolvent enterprises which had no chance to turn around were declared bankrupt and shut down. Pensions, unemployment insurance, and medical insurance systems were further reformed and improved as part of the national endeavor to promote the overhaul of SOEs. All these fiscal measures played an important role in optimizing economic structure, fostering stable economic growth, and curbing inflation. They also created a favorable environment for deepening the SOE reform and conducting strategic reorganization.

3. Achievements of Moderately Tight Fiscal Policy

From 1993 through 1997, the moderately tight fiscal policy enabled effective countercyclical adjustments. The inflation was effectively curbed, and the growth was moderate. High growth and low inflation laid a solid base for the sustainable and sound development of China’s economy.

3.1 Successful “Soft Landing”

After three years of macro control, China’s economy achieved a successful “soft landing,” with growth and inflation rates kept within in appropriate limits. The tension in macroeconomic operations was significantly alleviated.

3.1.1 Gradual elimination of overheating

The overexpansion of investment and consumption was gradually contained as a result of years of implementing moderately tight fiscal and monetary policies. The total fixed asset investment grew year-on-year 17.5% in 1995, 14.8% in 1996, and 8.8% in 1997. These were 44.3, 47 and 53 percentage points lower respectively than the 1993 figure. The total retail sales grew 26.8% in 1995, 20.1% in 1996, and 10.2% in 1997, down 3, 9.7, and 19.6 percentage points respectively from that in 1993. The CPI growth rate declined from 24.1% in 1994 to 8.3% in 1996 and 2.8% in 1997. The growth rate of the retail price index shrank from 21.7% in 1994 to 6.1% in 1996 and further to 0.8% in 1997. Economic growth moderated. The GDP grew 14% in 1993 and 13.1% in 1994. The rate fell to 10.9% in 1995, and further to 10% in 1996, and 9.3% in 1997. Economy enjoyed high growth and low inflation (Exhibits 2.11, 2.12, and 2.13).

3.1.2 Gradual rise of economic efficiency

The moderately tight fiscal policy not only stabilized economic growth but also enhanced the economic efficiency. In terms of comparable prices, the per capita annual net income of rural residents increased from 3.2% in 1993 to 9% in 1996, the highest in that period. At the same time, the per capita disposable income of

urban residents grew steadily. In 1996, the trade surplus stood at US$12.2 billion, while foreign exchange reserves reached US$105 billion. The total grain output hit a record high of over 500 billion kilograms, an increase of 37.9 billion kilograms from that in 1995 (Exhibits 2.14, 2.15, and 2.16).

3.1.3 Improving fiscal and financial situations

Fiscal order took a turn for the better. Cases of unauthorized charges and tax reduction and exemption decreased substantially. Reform of the fiscal system achieved a breakthrough, and a mechanism for maintaining a stable growth of fiscal revenue was established. In the three years from 1995 to 1997, fiscal revenue increased by 343.3 billion yuan, exceeding the total increment over the previous five years. This significantly enhanced the government’s capacity for macro control. Particularly, the growth rate of fiscal revenue had overtaken that of fiscal expenditure during those three years, which helped keep fiscal deficit within the budgeted limits.

Financial order was straightened out, with illegal fundraising, disorderly inter-bank lending, and illicit establishment of financial institutions brought under effective control. Residential savings increased gradually, reaching 3.9 trillion yuan by the end of 1996. Financial stability was restored. Money supply in 1995 was 59.7 billion yuan, the lowest over several years. At the end of 1996, M1 grew 18.9% and M2 25.3%, both falling in an appropriate range (Exhibits 2.18, 2.19, and 2.20).

3.2 Improving Fiscal Regulatory Mechanism

The early 1990s was an initial period for China’s transition from planned to market economy. The macro control during that period was dominated by the planning means and supplemented by the market tools. The control model was basically a continuation of the traditional method called “sluice up and sluice down,” which tended to result in a vicious circle, i.e., decentralization leading to disorder, which called for centralization and then caused stagnation, forcing an eventual return to decentralization. The government was exploring effective ways of fiscal regulation. After 1993, the innovations in the fiscal system and the introduction of a moderately tight fiscal policy enabled a “soft landing” for China’s economy and improved the fiscal management mechanism.

When the moderately tight fiscal policy was introduced, the central government sized up the economic situation and solicited opinions from local governments, enterprises, and economists. A thorough analysis of the macroeconomic situation led to the conclusion that economic overheating was caused mainly by defective institutions in the old economic system at a time when the socialist market economic system had yet to be put in place. To tackle overheating, market-oriented reform had to be accelerated, economic tools applied, and macroeconomic control improved and enhanced.

In view of this, instead of resorting to administrative commands, the Chinese government relied mainly on economic means of adjusting economic policies, conducting structural reforms to implement this round of macro control in strict accordance with the fundamental rules of the market. In 1994, the government came up with a series of reform measures to address issues in fiscal and tax policies, financial affairs, foreign trade, foreign exchange, economic planning, investment, and pricing so as to better integrate institutional reform and macro control. These macro control measures helped resolve the problems in economic activities, reinvigorated the microeconomic entities, and enhanced the role of the market. These measures are significant in that it symbolized a fundamental shift in both perception and approach of how the government managed the economy. They also presented a successful example of how the Chinese government attained the goal of macro control via reform and development.

3.3 Laying a Solid Foundation for Withstanding the Asian Financial Crisis

In 1997, some Asian countries experienced a financial crisis. The crisis affected China, but the country managed to sustain a relatively high growth. This was due largely to its implementation of moderately tight fiscal and monetary policies several years earlier, which created a favorable environment for macroeconomic operations. In addition, China also seized the opportunity to push further its economic restructuring with focus on improving the economic operational mechanisms. This had laid a solid foundation for sustainable economic development, and significantly enhanced the country’s capability to withstand the financial crisis. In hindsight, had the government failed to adopt the moderately tight fiscal and monetary policies, failed to achieve the “soft landing”, and failed to establish a fiscal system to ensure stable fiscal revenue growth, China would have inevitably experienced a massive slowdown under the extensive financial crisis. The moderately tight fiscal and monetary policies adopted by the Chinese government proved timely, correct, and highly effective.