3 Proactive Fiscal Policy

1. Background

2. Major Proactive Fiscal Policy Measures

3. Basic Achievements of Proactive Fiscal Policy

In 1998, THE CHINESE government decided to adopt a proactive fiscal policy. This is the second major shift in the government’s macro control endeavor initiated in the process of building a socialist market economy. The shift represented a timely and resolute move taken by the government to address the insufficient effective demand, the deflationary trend, and other new issues that emerged after the outbreak of the Asian financial crisis in 1997.

1. Background

The proactive fiscal policy was adopted to address the impact of the Asian financial crisis on China’s domestic economy. At the time, China faced a very harsh external and internal economic environment. Deep-rooted conflicts, such as structural imbalances brought on by a long period of redundant construction, became more pronounced than ever against the backdrop of a restrained domestic market and a dramatically changing international economic environment. At the same time, insufficient domestic demand, declining foreign trade, and decelerating economic growth all posed serious challenges to China’s economy (Exhibit 3.1).

1.1 Drastic Fall in Foreign Trade and Capital Inflow

The Asian financial crisis, which broke out in Thailand in July 1997, spread quickly to other Southeast Asian countries. As these countries were China’s main trade and investment partners, the worsening crisis greatly impacted China’s foreign trade and capital inflow: (i)

Exports were hit heavily. China’s total volume of exports grew 12.8% in the first quarter of 1998, but only 7.8% in April. It turned to a negative growth in May for the first time in 22 months and in June grew just 1.6%. As a result, the total volume of exports for the first half of 1998 grew only 7.6%, far below 26.2% in the first half of 1997, and 20.9% for the whole year of 1997. (ii) Foreign direct investment (FDI) declined dramatically. The crisis aggravated deflation in many economies and crippled enterprises’ ability to raise funds for investment. As a result, large amounts of international capital flew back to the United States and Europe, leading to reduced investments in Asia. Before the crisis, investments from Asian countries and regions accounted for over 80% of China’s total FDI. In 1997, this proportion fell to 75.6% and then to 68.7% in 1998 (Exhibit 3.2).

1.2 Slowing Consumer Demand

In the second quarter of 1998, a survey conducted among depositors in 34 large and medium-sized cities showed that, only 21% of them felt their income was rising (the lowest since 1993), and only 23.3% believed their income would rise in the following one to two years, 5.8 percentage points lower than that in the first quarter. At the same time, their expected expenditure rose dramatically amid progressive reforms being implemented in housing, pension, health, and education. As for why they saved, the top five reasons given were

daily expenses (24.7%), children’s education (13%), housing (12.7%), purchase of luxury goods (7.9%), and pensions (7.4%).

As a consequence of this expected income reduction and expenditure increase, coupled with high real interest rates, residents’ marginal propensity to save rose while their marginal propensity to consume declined. Estimates showed that from 1979 to 1996, the marginal propensity to consume ranged from 0.6 to 0.8, and this declined to 0.55 in 1997 and to 0.46 in 1998. As a result, the consumer demand grew slowly, causing a continual drop in the total retail sales from 20.1% in 1996 to 10.2% in 1997 and 6.8% in the first half of 1998. Before the 1990s, China had operated a shortage economy with prominent features of the seller’s market. The situation changed thereafter, when aggregate demand and supply struck a balance. However, structural problems surfaced, and more and more products became oversupplied. A survey in the first half of 1998 showed that, 74.2% of the 601 surveyed products were oversupplied, 25.8% maintained a balance between supply and demand, and none in short supply. The emergence of a buyer’s market meant that China’s economy began to face the constraints of market demand (Exhibit 3.3).

1.3 Sluggish Investment Demand

Since 1998, investors have become more risk-averse due to decelerated consumer demand, protracted financial reform, and discouraging market expectations. Enterprises attached more importance to investment returns. A survey of 5,000 industrial enterprises in terms of their investment orientations revealed that, with a general reduction of government intervention, which had constrained corporate investment over the past years, enterprises based their investment decisions largely on a desire to meet market demand and survive competition. Enterprise investment was seriously restricted by the slack demand. Investment areas with promising high returns were few and far between, leaving enterprises with few options. The severe imbalance of supply and demand

resulted in continuing price cuts for both raw materials and consumer goods. Thus, many enterprises lost their competitiveness and suffered significant losses. Even those with a certain competitive edge found their market shares shrinking quickly. Consequently, the expected returns on investment decreased and investment risks surged, leading to a debilitated capacity for independent investment among enterprises. As commercial banks had started to exercise asset liability management, they became more cautious and reluctant to lend. First, they were suffering from non-performing loans; second, there was a lack of qualified agents engaged in project feasibility studies and risk assessment amid uncertain market conditions. While considered beneficial to long-term economic development and restructuring, this new situation had a negative impact on investment. Total fixed asset investment decelerated, with the growth in 1997 falling six percentage points from the previous year to 8.8%, and the growth in the first five months of 1998 continuing to decline by 1.3 percentage points.

1.4 Continuing Price Drops

Owing to insufficient demand and structural surplus, China’s main price indices declined every month from 1998. The prices of upstream industrial products, a leading price index, experienced a continual drop from mid-1997. In June 1997, the ex-factory prices of industrial goods stopped increasing, and started to decrease by 0.4% before going down further by 1.3%, 3.2%, and 4.9% respectively in January, March, and June 1998, bringing the average fall in the first half of 1998 to 3.4%. The purchase price index (PPI) of raw materials, fuel, and power also took a downward trend starting from January 1998 by 0.4%, and then by 2.3% and 5.2% respectively in March and June, with the first half of that year recording a fall of 2.3%. The general retail price index began to decline in October 1997 by 0.4%. This decline continued for nine running months until it hit 3% in June 1998. The consumer price index (CPI) began to fall by 0.1% in February 1998, and 1.3% in June, reflecting a certain level of deflation (Exhibit 3.4).

1.5 Pronounced Economic Structural Imbalance

The Asian financial crisis exposed and exacerbated the irrational structural problems that had long troubled the Chinese economy:

• Irrational industrial structure. Low-tech products were oversupplied while high-tech ones were undersupplied. A 1997 survey of major enterprises in China on the manufacturing capacity of 67 conventional industrial products showed that 33.3% of these products had a rate of operation (ROP) above 80%, 32.8% a low ROP (60–80%), and 33.9% in an extreme insufficient situation (below 60%). The situation worsened in 1998 against a backdrop of insufficient domestic demand. However, there was a short supply of tech-intensive and marketable products, in particular large and packaged equipment, as well as high-tech products. Statistical data showed that, of the industrial

  equipment produced by China then, only a third involved relatively advanced technology, and just 13% reached the advanced technological level of the world in the 1980s.

• Imbalance between the urban and rural areas. The pace of urbanization and industrialization was slow in rural areas. Town and village enterprises (TVEs), which had been expanding at an extraordinary speed during the previous two decades, now experienced a noticeable slowdown amid fierce competition and high polarization. Rural labour found their employment opportunities reduced in the cities because of their lack of competitiveness and the rising urban unemployment rate. As a result, the income gap further widened between rural and urban residents, causing the issue of a “dual economy” (rural economy versus urban economy) to become even more prominent. The ratio of per capita income between urban to rural residents enlarged from 2.47:1 in 1997 to 2.51:1 in 1998.
• Unbalanced regional development. The Chinese government attached great importance to regional balance, adopting a series of policies and measures in the mid-1990s to expedite the development of the central and western regions of the country, and initial results were achieved. However, due to historical and geographical factors, economic growth in these regions was slower than that in the eastern region, causing the regional disparity to continue to widen. In 1997, the eastern, central, and western regions accounted for 57.8%, 28.2%, and 14% respectively of China’s GDP, and these proportions changed to 58.1%, 28%, and 13.9% respectively in 1998.

The confluence of the above mentioned factors placed the Chinese economy in an unprecedentedly difficult situation in 1998. Economic growth was at a cyclical low, with GDP growing only 7% in the first half of 1998, down 2.5 percentage points from the same period in 1997, and substantially below the targeted 8% for the whole year. Economic efficiency also declined. SOEs generated an unparalleled net loss of 8.88 billion yuan for the first five months of 1998. Unemployment was mounting, bringing the registered urban unemployment to 6 million, which represented an unemployment rate of 3.1%. Economic slowdown led to insufficient job creation, bringing more pressure on reemployment. Residents’ income and savings growth also declined. The increase in per capita disposable income of urban residents decelerated from 8.5% in 1994 to 3.4% in 1997. The growth rate of per capita net income of rural residents fell from 5.0% to 4.6%, and that of residents’ savings dropped from 45.8% to 20.1% during the same period.

Before 1997, the central government targeted its macro control measures at curbing inflation. This was achieved mainly through the adoption of tight fiscal and monetary policies, such as controlling the central bank’s money supply, raising interest rates, and reducing fiscal expenditure. As a result, the government had little experience of dealing with deflation. The key to addressing deflation was to expand domestic demand. Considering this, the Ministry of Finance (MOF) proposed a series of policy measures. Fully aware of the importance of taking precautions after repeated research, the central government made a timely and resolute decision in 1998 to abandon the relatively tight fiscal policy for a proactive or expansionary one in order to attain the targeted economic growth of 8%. On August 29, 1998, the proposed budget adjustment plan, which called for an increase in fiscal deficit by 40 billion yuan to 96 billion yuan, was approved at the Fourth Session of the Standing Committee of the Ninth National People’s Congress. According to the plan, an additional 100 billion yuan-worth of long-term construction treasury bonds would be issued, which was matched by another 100-billion-yuan bank loans. All the funds thus raised would be funnelled into infrastructure construction. A proactive fiscal policy was thus formally ushered in.

2. Major Proactive Fiscal Policy Measures

China began to implement a proactive fiscal policy in 1998 and three major measures were taken that very year:

• Issuing an additional 100 billion yuan-worth of long-term construction treasury bonds purely for infrastructure construction in six areas: irrigation, transportation and communication, urban infrastructure, environmental protection, construction and improvement of urban and rural power grids, and depots for national grain reserves.
• Issuing 270 billion yuan-worth of special treasury bonds for the four large state-owned commercial banks to increase their capital adequacy.
• Increasing export tax rebates to support the export of textile materials and products, textile machinery, coal, cement, steel, ships, electromechanical products, and light industrial products.

Thereafter, considering the unfavourable external situation and insufficient domestic demand, the government decided to continue the proactive fiscal policy to build on what had been achieved in expanding demand, and to secure sustainable, rapid, and sound economic growth. Beginning in 1999, the government started to diversify the proactive fiscal policy’s toolbox so as to synergize various fiscal instruments, such as public investment, taxation, income distribution, discount interest, and transfer payments. The government extended its attention to tax policies while recognizing the role of fiscal expenditure. Equal importance was attached to expanding consumption and export on one hand, and increasing bond-financed project investment on the other hand. Efforts were also made to coordinate infrastructure development and corporate technological improvements.

2.1 Issuing More Long-term Construction Treasury Bonds to Promote Infrastructure Development

From 1998 to 2004, the government issued 910 billion yuan-worth of long-term treasury bonds for construction. By the end of 2004, 864.3 billion yuan was committed for bond-financed projects in the following areas:

• 259.6 billion yuan or 30% for agriculture, forestry, water conservancy, and eco-development;
• 171.1 billion yuan or 19.8% for development of transportation and communication infrastructure;
• 131.7 billion yuan or 15.2% for urban infrastructure development;
• 77.5 billion yuan or 9% for technological improvement and industrial upgrading;
• 68.8 billion yuan or 8% for upgrading rural power grids;
• 43.3 billion yuan or 5% for developing infrastructural facilities for education, culture, health, and tourism;
• 35.2 billion yuan or 4.1% for building depots for national grain reserves;
• 31.2 billion yuan or 3.6% for environmental protection;
• 18 billion yuan or 2.1% for infrastructure improvement for courts, public security, procuratorial, and judicial organs.

The government had improved the allocation of bond proceeds year by year. From 1999 through 2001, besides the six areas of investment selected in 1998, new areas such as western development, major sectors’ technological upgrading, high-tech industry, transforming farmland back to forest (or grassland), education, and infrastructure improvement for courts, public security, procuratorial, and judicial organs were added. From 2002 onward, investment priorities were shifted to rural development, structural adjustment, central and western region development, science and technology, education, and eco-environment improvement, with particular attention paid to striking a balance between urban and rural areas, among different regions, and between social and economic development (Exhibit 3.5).

2.2 Adjusting Tax Policies to Strengthen the Regulatory Role of Taxation

To encourage investment and attract more advanced technologies and equipment from abroad, the government reduced the import tariff rate from 17% at the end of 1997 to 10.4% in 2004. Meanwhile, duties and import-related taxes were exempted, within the stipulated limits, on the imported equipments which would be used for state-encouraged domestic projects and foreign investment projects. The government halved the tax for adjusting the orientation of fixed assets investment in the latter half of 1999 and suspended it in 2000. For enterprises’ technological upgrading encouraged by state industrial policies, 40% of the costs for purchasing domestically-made equipments were deductible from payable corporate income tax.

To stimulate individual consumption, interest tax on deposits resumed in November 1999. Consumption tax on skin- and hair-care products (excluding toilet soap) was reduced from 17% to 8% in 1999. Meanwhile, consumption tax on environment-friendly vehicles was collected at 70% of its normal rate. To promote housing consumption and circulation, real estate-related business tax, deed tax, and land value-added tax were all reduced or exempted in August 1, 1999.

To promote export, VAT rebate on export commodities was increased eight times, pushing the average tax rebate from 8.3% in 1998 to 15% in 2002. At the same time, through improving export rebate administration, enterprises with high tax-paying credit were allowed to enjoy simplified review/approval procedures and quick rebate reimbursement. In 2004, the export tax rebate management system was further reformed, which optimized the tax rebate rates, introduced the mechanism of sharing export tax rebates between central and local governments, and cleared accumulated payable export tax rebates. As a result, exports gained new momentum.

To support the strategic adjustment in economic structure, boost high-tech industries, promote development in central and western regions, and revitalize the old industrial bases in the northeastern region, a preferential tax policy package was introduced that covered income tax, tax on the use of arable land, tax on special agricultural products, and import tax. In 2000, a series of tax incentives were announced to shore up the development of high-tech industries such as software design, integrated circuit, and TFT-LCD, covering VAT, corporate income tax, and import tax. To reform the financial system and improve the operating efficiency of financial institutions, the business tax rate imposed on financial and insurance companies was reduced yearly by one percentage point from 2001, down to 5% in 2003. The stock exchange stamp tax rate was also reduced to 4 ‰ on June 15, 1998, with a further decrease to 2‰ in October 2001. These effective incentives contributed to stable development in the financial and securities industry.

2.3 Adjusting Income Distribution Policies to Foster and Expand Consumer Demand

The Chinese government raised civil servants’ basic salary (including quasi civil servants) and retirees’ pension four times in a row: July 1, 1999, January 1, 2001, October 1, 2001, and July 1, 2003. At the same time, annual bonus, and allowances for remote and harsh areas were also put in place. As a result, civil servants’ average monthly basic salary increased to 877 yuan (bonus included) at the end of 2003, up 119% from 400 yuan in 1998, the fastest and largest wage increase since the founding of PRC. For this purpose, the national budget allocated 639 billion yuan, of which 371.4 billion yuan was disbursed by the central government.

Meanwhile, efforts were made to improve the social security system. In 1998, a basic living guarantee system was introduced to help workers laid off by SOEs. The Regulations on Unemployment Insurance and the Regulations on Minimum Living Guarantee for Urban Residents were promulgated in 1999, marking the official establishment of a social security system in China. The “three safeguard lines”— allowances for SOE laid-off workers’ basic living costs, unemployment insurance repayments, and urban residents’ minimum living allowances—were increased by 30% on July 1, 1999. At the same time, pension for enterprises’ retirees was increased four times. As a result, national fiscal expenditures on these three aspects jumped from 12.3 billion yuan in 1998 to 103.5 billion yuan in 2004 at an average annual growth of 42.6%, adding up to 446.4 billion yuan. Adding in expenditures on healthcare, social relief, welfare, and pension for retirees in the public sectors, total expenditures on social security increased from 77.5 billion yuan in 1998 to 341 billion yuan in 2004 at an average annual growth of 28%, which was obviously higher than that of total national expenditure. With its share in total national fiscal expenditure increasing tremendously from 7.2% in 1998 to 12.4% in 2004, the social security system could play an effective role as an automatic stabilizer. The implementation of an adjusted income distribution system further enhanced the consumers’ purchasing power, which in turn boosted domestic demand.

2.4 Improving Fiscal Management System to Increase Transfer Payments for Central and Western Regions

To promote harmonized regional economic development and improve the market economic mechanisms, the government reformed the corporate-income-tax-sharing system in 2002. As a result, the central and local governments started to share income taxes at a fixed percentage instead of dividing them into central income taxes and local ones according to the ownership of enterprises. The central and local governments shared the incremental income tax in 2002 evenly. From 2003 onward, the shared ratio was changed to 6:4. What the central government gained from the increased income taxes was fully used as added transfer payments to local governments, especially those in the central and western regions.

To safeguard local governments’ financial capacity, the fiscal transfer payments increased continuously. In 2004, the central government’s total expenditure in the form of tax returns and subsidies to local governments amounted to 1,040.8 billion yuan, up from 249.3 billion yuan in 1998, at an annual growth rate of 26.8%. In the last several years, the central government increased general transfer payments, transfers to minority regions, transfers for salary increases, and transfers for rural tax-for-fee reform. Of the increased transfer payments, a larger share was allocated to the central and western regions. In 2004, the transfer payments from central to local governments totalled 602.8 billion yuan, far exceeding tax returns (405.1 billion yuan). In addition, to shore up the western development strategy and the rural tax-for-fee reform and protect and improve the eco-environment in western region, MOF came up with additional transfer payments to subsidize grassroots-level governments, which suffered fiscal revenue loss from implementing the programs for conservation of natural forest, restoring farmland to forest (grassland), and carrying out the rural tax-for-fee reform. In 2002, the central government appropriated 1.98 billion yuan in subsidies for conserving natural forests and restoring farmland to forest (grassland). Transfer payments for rural tax-for-fee reform amounted to 24.5 billion yuan in 2002, 30.5 billion yuan in 2003, and 52.3 billion yuan in 2004.

The increased transfer payments over recent years have considerably enhanced local governments’ financial capacity, especially those in central and western regions, and contributed to coordinated development among different regions and between urban and rural areas (Exhibit 3.6).

2.5 Optimizing Non-tax Revenue Policies to Expand Domestic Demand

To lighten the non-tax burden on enterprises and individuals, the fiscal authorities, working together with other government agencies,

stepped up their efforts to crack down on unauthorized collection of fees and charges. From 1998 to 2004, they abolished 1,913 categories of fees and charges and lowered another 479, reducing social burdens by 149 billion yuan. To be specific,

• In 1998, 727 fees were eliminated, reducing social burdens by 37.7 billion yuan;
• In 1999, 408 fees were revoked and 479 items were lowered, reducing social burdens by 24.5 billion yuan;
• In 2000, 238 fees were removed, reducing social burdens by 14.5 billion yuan;
• In 2001, 69 fees were terminated, reducing social burdens by 30 billion yuan;
• In 2002, 298 types of irregular fees and charges on enterprises were cancelled, equivalent to 21 billion yuan;
• In 2003, 65 types of irregular fees and charges on enterprises were suspended, equivalent to 14 billion yuan;
• In 2004, 108 types of irregular fees and charges on enterprises were rescinded, equivalent to 7.3 billion yuan.

Traffic and vehicle charges and fees were among the first to be regulated. The surcharge on vehicle purchase was replaced with a vehicle purchase tax in January 2001, marking a substantial step forward in the tax-for-fee reform.

In addition, to put rural tax and fee management in order, agricultural taxes were also restructured. The tax-for-fee reform was progressively pushed forward, starting with a pilot project in Anhui Province in 2000 before spreading across the country in 2003. As an initial result achieved by the reform, the financial burden on farmers experienced an average reduction of 30%. Efforts were doubled in 2004 to carry on this reform. Since administrative fees and charges and government funds were both classified as non-tax revenue, reducing fees and charges, like tax reduction, could effectively strengthen corporate investment and individual consumption.

As the above mentioned measures showed, to sustain the development of economy and public finance, in the process of implementing the proactive fiscal policy, the Chinese government attached great importance to the orientation and magnitude of each fiscal policy measure as well as the harmonization of short-term measures and long-term policy goals. These measures were united by the following features:

• Right policy decision. In response to slack demand and a sluggish economy, the government made a timely and resolute decision to adopt an expansionary fiscal policy to spur a fast economic upturn. For instance, expanded government direct investment, which was designed to stimulate demand, was largely funnelled into projects already underway or short-term (one to three years) infrastructure projects.
• Rational policy orientation. The proactive fiscal policy was targeted at expanding the aggregate demand and promoting structural reform. Equal emphasis was placed on the effects of short-term, mid-term, and long-term policies.
• Well-coordinated policies. The fiscal policy was implemented in close connection with the monetary policy. To raise funds, a fixed proportion of treasury bonds were issued to state-owned commercial banks. For infrastructure construction, fiscal investment was bundled with bank credit. Special treasury bonds were issued to raise the capital adequacy of state-owned commercial banks, thus promoting financial reform.

3. Basic Achievements of Proactive Fiscal Policy

The proactive fiscal policy was a countercyclical adjustment actively adopted by the government in line with the rules of the market economy in a rapidly changing economic environment both at home and abroad. It marked a significant event in the history of China’s fiscal control. Through effective macroeconomic control, China successfully withstood the impact of the Asian financial crisis. As a result, China’s macroeconomic environment improved remarkably, social demand recovered in all aspects, the economy continued its rapid growth, deflation was effectively curbed, economic restructuring was steadily pushed forward, and the quality and efficiency of economic growth were raised. At the same time, its fiscal strength was further enhanced.

3.1 Social Demand Picked Up and National Economy Accelerated

More long-term construction treasury bonds were issued to expand government spending. Tax incentives, such as suspending fixed asset investment regulatory tax and adjusting corporate income tax, were adopted to stimulate social investment demand. Income distribution was readjusted to spur consumption. Foreign trade and export were boosted by measures to increase export tax rebates. Thanks to all these policy measures, social demand was stimulated, growing steadily and rapidly, and giving a strong boost to the economy.

3.1.1 Investment continued to grow rapidly

On the one hand, China’s accelerating urbanization and the increasing proportion of heavy industry in economy created a lasting appetite for more investment. On the other hand, increased government investment, except for enlarging total investment, enhanced China’s capability for self-sustained economic growth in a better environment achieved through a chain reaction across different industries. Fixed asset investment increased to 7,047.7 billion yuan in 2004 from 2,494.1 billion yuan in 1997, with its growth accelerating year by year, from 8.8% in 1997 to 26.6% in 2004, up 17.8 percentage points. In 2004, the contribution rate of investment demand growth to overall economic growth reached around 50%, up nearly 20 percentage points over that of 1997 (Exhibit 3.7).

3.1.2 Consumer demand increased steadily and rapidly

Infrastructure development improved people’s living conditions and consumption environment. At the same time, more effort was made to readjust income distribution and increase the income level of urban and rural residents, which in turn enhanced their purchase power. In 2004, the per capita incomes of urban and rural residents increased 7.7% and 6.8% respectively in real terms or 4.3 and 2.2 percentage points higher than those in 1997. The interest income tax on deposits was reintroduced to further encourage consumption. This resulted in the total retail sales of consumer goods climbing from 3.34 trillion yuan in 1998 to 5.95 trillion yuan in 2004, with its growth rate jumping to 13.3% in 2004 from 6.8% in 1998, up 6.5 percentage points. The growing consumer demand played a prominent role in spurring economic growth (Exhibit 3.9).

3.1.3 Export expanded steadily and rapidly

Export tax rebates were increased several times, the pattern of tax rebates for export commodities was optimized, and measures, such as tax exemption, reduction, and refunding, were fully applied to production enterprises. All these policy measures effectively boosted export. The export tax rebate system was also restructured to address the rebates in arrears, effectively alleviating the liquidity pressure on foreign export companies and increasing their export capacity. Total export volume increased to US$593.3 billion in 2004 from US$183.7 billion in 1998, with a growth rate of 35.4% in 2004 from 0.5% in 1998, skyrocketing nearly 35 percentage points. Expanding external demand also played a significant role in boosting economic growth (Exhibit 3.12).

3.1.4 Economic growth accelerated

From 1998 to 2004, China’s GDP growth rates stood at 7.8%, 7.6%, 8.4%, 8.3%, 9.1%, 10%, and 10.1%, respectively, indicating another round of rapid growth. Analysis by relevant institutions showed that China’s proactive fiscal policy contributed to economic growth by one to two percentage points annually during this period. If the combined policy effects were taken into consideration, the overall

contribution of fiscal policy to economic growth would be even bigger (Exhibit 3.14).

3.2 Prices Stabilized and Deflation Curbed

Under the combined effects of a proactive fiscal policy and a prudent monetary policy, the economic environment was significantly improved and the capability for self-sustained growth was reinforced. Meanwhile, investors and consumers showed higher confidence in market prospects, leading to a rise in market demand. This drove up prices steadily, thus curbing deflation (Exhibit 3.15).

3.2.1 CPI and RPI trended up

Since the fourth quarter of 2002, the CPI began an upward trend. In 2003–2004, the CPI increased by 1.2% and 3.9% respectively. By components:

• Food prices increased 3.4% in 2003 and 9.9% in 2004, with grain prices rising 2.3% and 26.4% respectively;
• Housing prices increased 2.1% in 2003 and 4.9% in 2004;
• Prices for services, such as entertainment, education and culture increased 1.3% in both years.

In the fourth quarter of 2003, the Retail Price Index (RPI) trended up, showing signs of recovery. In 2004, the RPI increased 2.8%, while in 2005 it dropped 0.1%.

3.2.2 Price indices of upstream products including industrial ones rose steadily

In 2002, the leading indices of industrial products and others began to climb. The ex-factory price index of industrial products grew 2.3% in 2003 and 6.1% in 2004, the purchase price index of raw materials, fuel, and power increased 4.8% and 11.4% respectively, and the fixed asset investment price index was up 2.2% and 5.6% respectively.

3.3 Economic Restructuring Accelerated and Growth Momentum Enhanced

Over the past seven years, the issuance of long-term construction treasury bonds has triggered large-scale investments, including supporting funds from local governments, bank loans, and enterprises’ self-raised funds, adding up to around four trillion yuan. As of the end of 2004, fiscal investments exceeded 3 trillion yuan, and a number of key infrastructure projects of national significance were completed. Economic structure was remarkably optimized.

3.3.1 Transportation developing at an unprecedented pace

During these years, 5,500 kilometres of new railway lines were laid, including 2,998 kilometres of double-track lines and 1,054 kilometres of electrified lines. The total railway length reached 72,000 kilometres, ranking first in Asia and third in the world. The new railway network covered almost all provinces in the mainland China. The construction of principal highways, highways in poverty-stricken counties, and city-county roads in the western region totalled 104,000 kilometres, of which 12,000 kilometres were expressways. A total of 35 airports were built or extended in central and western regions. The navigation channels of the Yangtze River and the Pearl River at their estuaries, and that of the Beijing-Hangzhou Grand Canal were rebuilt. Navigation-power control projects on the Xijiang and Xiangjiang Rivers were also completed.

3.3.2 Construction of water conservancy projects strengthened

Over 30,000 kilometres of the embankments of major rivers and lakes were reinforced. A total of 1,324 endangered reservoirs were repaired and reinforced. The South-North Water Diversion Project was steadily pushed forward with the launching of five individual projects. The projects to harness the Huai River progressed at a quick

pace with eight of them completed or approaching the end. The Tarim River control projects continued fruitfully with six emergency water discharges completed to its lower reaches.

3.3.3 Rural infrastructure improved considerably

The goal stipulated in China’s Tenth Five-Year Plan (2001–2005)—providing 50.2 million rural residents with access to safe drinking water—was substantially achieved. The renovation of inter-county and rural highways made fast progress. Water-saving facilities in large irrigation areas were upgraded; an additional 110 million mu of cropland either came under irrigation or their irrigation conditions were improved. The project of returning pastures to grassland in

western region revitalized a total of 190 million mu of heavily degraded pastures. Methane gas tanks were built in 2.07 million rural households. In addition to these improvements, rural power grids were either built or upgraded in over 2,400 counties, which increased farmers’ access to electricity, lowered electricity rates, improved rural living conditions, and stimulated rural consumer demand.

3.3.4 Industrial upgrading and restructuring accelerated

The government boosted corporate technological upgrading through discount interest. A number of projects were carried out on technological upgrading, high-tech industrialization, and substitution of domestic equipment for foreign equipment. The development of high-tech industries was promoted. Specifically there are

• 118 projects to rejuvenate old industrial bases in areas including Northeast China with a total investment of 15 billion yuan;
• 43 projects to restructure key industries with an investment of 9.5 billion yuan;
• 73 projects to mechanize coal mining and dressing methods with an investment of 10.7 billion yuan;
• 156 IT upgrading projects with a total investment of 7.4 billion yuan;
• 118 projects for introducing chain-store operation and modern logistics to key distribution companies with 4.4 billion yuan injected;
• 35 major or demonstration projects for energy and water efficiency as well as comprehensive resource utilization with a total investment of 5.6 billion yuan.

3.4 Living Conditions Improved and Social Undertakings Advanced

Project investment through issuing treasury bonds aroused the enthusiasm of cities across the country for infrastructure construction and environmental protection. As a result, many cities took on a new look; educational facilities and people’s living conditions were also improved.

3.4.1 Ecological and environmental protection reinforced

As one of the landmark steps toward improving the ecological environment, the project to reforest formerly cultivated land saw remarkable results: 287.5 million mu of land was reforested. With the aim of protecting natural forests, an additional 82.2 million mu of non-profit ecological forest was planted. There was progress in the effort to control the sources of dust storms affecting Beijing and Tianjin, with a total of 165.8 million mu of sandy land brought under control. The treatment of water pollution in the Three Gorges reservoir area made progress. In this regard, 169 projects for the disposal of sewage and solid waste were planned, of which 133 have been completed. Projects aimed to control the pollution in the “three

rivers and three lakes” (the Liao River, the Hai River, and the Huai River; and the Taihu Lake, the Chaohu Lake, and the Dian Lake) and the Bohai Sea made fast progress, with 586 wastewater disposal projects planned, of which 377 have been completed.

3.4.2 Notable results achieved in urban infrastructure construction

Urban residents saw their housing conditions and living environment improved significantly. The daily water supply increased by 35.8 million tons, and the gas supply by 9.8 million cubic meters per day. The capacity of wastewater disposal was also lifted by 18 million tons.

3.4.3 Education, public health, and other social undertakings improved significantly

In education, 11 million square meters of college education infrastructure were constructed and 5,800 dilapidated buildings in primary and secondary schools were renovated. These improvements benefited 1.8 million students. In central and western regions, nearly 50,000 pilot projects of distance learning were completed in primary and secondary schools. With regard to the nine-year compulsory education, rapid progress was made in making it universally available throughout the western region. A total of 7,727 schools were constructed, reconstructed, or extended, making it possible to accommodate 7.73 million students, and 4.59 million boarders. In health related areas, the establishment of National Centers for Disease Control (CDCs) progressed steadily, with 1,296 such centers planned at provincial, city, and county levels. Most of them went into operation. In addition, 3,787 town and township hospitals were built, renovated, or extended in 360 counties in central and western regions. These improvements benefited 110 million rural residents.

3.5 Fiscal Strength Was Significantly Enhanced due to Fast-growing Revenue

The proactive fiscal policy had not only effectively propelled economic growth, but also promoted sustained and rapid growth of fiscal revenue. As a result, China’s fiscal strength and its capability of macro control were considerably enhanced (Exhibit 3.20).

3.5.1 Fiscal revenue growing steadily

China’s fiscal revenue grew significantly from 1998 onward. Its year-on-year increment in 1998 was 122.5 billion yuan, 156.8 billion yuan in 1999, 195.1 billion yuan in 2000, 299.1 billion yuan in 2001, 251.8 billion yuan in 2002, 281.2 billion yuan in 2003, and 468.1 billion yuan in 2004. The accumulated revenue increase reached 1,774.5 billion yuan with an average annual increase of 17.3% during this seven-year period that witnessed higher and more stable revenue increase than ever before. China’s revenue growth constantly moved up the ladder. It jumped over the one-trillion-yuan bar to hit 1.1444 trillion yuan in 1999, 1.6386 trillion yuan in 2001, 2.1715 trillion yuan in 2003, and 2.6396 trillion yuan in 2004.

3.5.2 Mechanism for stable revenue growth further consolidated

China’s rapid growth in fiscal revenue was mainly due to the rapid rise in its tax revenue. From 1998 to 2004, the annual increases of tax revenue were 102.9 billion yuan, 142 billion yuan, 189.9 billion yuan, 272 billion yuan, 233.5 billion yuan, 238.1 billion yuan, and 414.8 billion yuan respectively. During this period, tax revenue achieved a total growth of 1.6 trillion yuan, accounting for 90% of the total fiscal revenue growth.

China’s tax revenue continued to climb, exceeding one trillion yuan to reach 1.1 trillion yuan in 1999, 1.5 trillion yuan in 2001, two trillion yuan in 2003, and 2.4 trillion yuan in 2004. Revenue from main taxes maintained fast growth. During the seven years, the average annual increase rates of revenue from consumption tax, VAT, business tax, VAT and consumption tax on imported goods, corporate income tax, and individual income tax were 12%, 15.5%, 15.3%, 32.8%, 22.4%, and 31.2% respectively. At the same time, the tax revenue structure was optimized. From 1998 to 2004, growth in the turnover tax (domestic VAT, consumption tax, and business tax) revenue took up 49.8% of the overall tax revenue growth, while the proportion of corporate income and individual income taxes was 25.6%, and 22.1% for import tax (tariff, consumption tax and VAT on imported products). It was clear that revenue growth relied mainly on the three main tax categories, and the mechanism for maintaining stable revenue growth was further consolidated.

3.5.3 Macro control capability noticeably enhanced

With continuous and rapid revenue growth, the “two proportions”—the proportion of fiscal revenue in GDP, and that of central fiscal revenue in the national total—showed a steady upward trend.

In 1997, the proportion of national revenue in GDP was 11%, and it climbed to 16.5% in 2004, representing a rise of 5.5 percentage points in seven years or 0.79 percentage points annually. The share of tax revenue in GDP rose from 10.4% in 1997 to 15.1% in 2004, up 4.7 percentage points in seven years or 0.67 percentage points in the annual average term. Meanwhile, the proportion of central fiscal revenue in the national total rose from 48.9% to 54.9%, up six percentage points in seven years or 0.86 percentage points annually. The “two proportions,” which reflect directly the degree of government control over social products or resources as well as the level of concentration of all governmental resources in the hand of central government, are indicators of the government’s capability for social and economic control and adjustment. Therefore, the constant increase of the “two proportions” points to a significantly enhanced government macro control and a marked increase in overall national strength.