Author: Professor Shusong Ba, Executive Director of the HSBC Financial Research Institute at Peking University, Chief Economist of China Banking Association
Haifeng Bai, China Merchants Asset Management (Hong Kong) Co., Ltd.
IIntroduction
The 1929 crash was the worst economic crisis in nearly a century and is still known as the "Great Depression". The economic and social impact of the Covid-19 pandemic is unprecedented and can be described as the "Great Isolation". The pandemic has caused a double blow to global supply chains and demand. The current impact of the pandemic on the global economy can be divided into three stages. The first stage of shock is defined as the supply from China. As an important global supply chain centre, China caused the suspension of production in some markets due to the pandemic in the first half of 2020. The second stage of shock came from demand in Europe and the United States, where economic activity slowed or even was suspended as the pandemic spread, in turn causing China's foreign trade orders to stall or fall. A third stage of shock came from some of the big developing countries, which are mainly commodity providers. Outbreaks in these countries have strained global commodity supplies. In the three stages of the pandemic, although the Chinese economy was hit first by the pandemic, it recovered fastest from the pandemic (Liu, Sun, and Zhang 2020). Over the past four decades, China has benefitted from the global division of labour and its industrial structures are constantly upgraded. From an observation of the overall trend, China's current economic growth shows four characteristics. From the perspective of population, China's economy is transforming from relying on demographic dividend growth to utilizing its human capital potential. From the perspective of industrial structure, China's economy is shifting from relying mainly on traditional industries to relying on new economic industries. From the perspective of science and technology, China's economy is changing from focusing on technology imports to relying on technological innovation. From the perspective of the demand side, China's economy is shifting from the original export drive to domestic demand drive. The anti-globalization brought by the pandemic has made China more aware of the seriousness of the problem. Covid-19 brings to mind Churchill's words: Never let a good crisis go to waste. In general, China's economy recovered quickly, and China used the pandemic as a stress test for its economy, seizing the opportunity to promote economic transition and financial innovation.
2Why is the Chinese economy recovering and transitioning faster
2.1. China has an ample policy toolbox
Covid-19 has had a major short-term impact on China's economy. Regional cooperation played an important role, and all provinces and cities in China provided assistance to Wuhan City which had been hit hard by the pandemic. Regional cooperation supported the economic recovery. China took a series of measures to support the real economy. From a monetary policy perspective, The Central Bank provided necessary liquidity. In order to reduce corporate financing costs, The Central Bank adjusted the MLF interest rate to decline LPR. In order to ensure the stable development of the real economy in the era of the pandemic, China stepped up credit support for small and medium-sized companies affected by the pandemic. From the perspective of fiscal policy, China adopted such fiscal policies as tax and fee reduction, social security payment delay, rent reduction and interest discount support for companies hit by the pandemic. From the perspective of employment policy, China encouraged flexible employment policies and salary management, and encouraged online work, so as to alleviate the employment pressure caused by the pandemic. 2.2. Economic stimulus measures: overseas demand versus Chinese supply In the face of the impact of Covid-19, China's approach to economic recovery differed from that of the U.S. and Europe. China has paid more attention to recovery supply-side, and Europe and the U.S. have been mainly focused on demand side recovery. For example, the government gave consumption coupons to residents for stimulating consumption in Europe and the U.S. Because the monetary and fiscal policy space is limited in Europe and the U.S., the government can only consider giving households consumption coupons directly to stimulate the recovery. China can recover its economy by promoting the recovery of production and work. More importantly, China has become a major centre of global production chain in the world. China has the capacity to resume production quickly. China's GDP was 3.2% in the second quarter and 4.9% in the third quarter in 2020. By contrast, GDP in Europe and the U.S. has fallen sharply in the second and third quarter in 2020. In the context of globalization, the global production is highly fragmented and segmented. MNEs have sliced the value chains finely and distributed them globally. The global layout of an industrial chain can not only reduce production costs but also improve production efficiency through the scale effect. After China's accession to the WTO, it has gradually integrated into the global industrial chain, and the proportion of its total foreign trade in the world has been increasing year by year. The overseas outbreak of Covid-19 has brought the economy to a standstill, while the integrity of China's industrial chain has provided the world with necessary supplies. The value of imports and exports in the third quarter of 2020 was 23.12 trillion yuan, up 0.7% over the same period last year and hitting a quarterly record high. The increase in imports and exports has prompted a rapid economic recovery in China. China exported a large amount of pandemic prevention materials and daily necessities to help countries hard hit by the pandemic to tide them over the difficulties.
3China's economic transition under the Covid-19 pandemic
3.1. Covid-19 as an accelerator of China's digital economy
The pandemic has a short-term impact on the economy, but at the same time, it is forcing the economy to achieve a change of growth. The SARS pandemic in 2003 accelerated the expansion of the online shopping population, while the Covid-19 pandemic in 2020 may become a catalyst for the rapid development of the digital economy. New business forms represented by online office, online education, online medical care, online games and fresh e-commerce have been rapidly developed, which have made up for the loss of the traditional economy. From the perspective of economic transition, the "forced" internet life in the pandemic greatly increased the internet penetration of Chinese households. Companies were "forced" to adopt telecommuting systems and switch to digital management mode. The government itself should also start to focus on "digital governance" by using digital technology, and start to strengthen government-company cooperation with IT companies. Under the influence of the pandemic, the development of entertainment, study and office work has not stopped, but accelerated. It is happening not only in China but also around the world. The impact on the tertiary industry is permanent. The tertiary industry accounts for an increasing proportion of China's economy. According to the National Bureau of Statistics, China's tertiary industry accounted for more than 50% of the total in 2015, and 53.9% in 2019 (Figure 1). Therefore, the pandemic has objectively accelerated the digital transition of traditional companies by affecting the tertiary industry. Under the impact of the pandemic, the traditional ways of working and learning were adjusted for the long term, such as cloud office, cloud classroom, cloud games, cloud commerce, cloud contract and cloud forum. In the medium to long term, the pandemic has also had a significant impact on the secondary industry. Traditional industries are also looking for digital transition, considering the possibility of increasing online demand. Online activities further accelerate the construction of 5G network demand. China will accelerate the construction of major infrastructure in the digital economy, such as 5G, Industrial Internet and Cloud Computing and so on. Application prosperity is driven by infrastructure, and investment in infrastructure construction continues to be driven after ecological improvement, thus forming a benign closed loop.
Figure 1. The composition of GDP in China
3.2. Covid-19 as an accelerator of establishing a "dual circulation" development pattern Many overseas countries have taken measures such as shutting down their borders, reducing traffic and locking down cities to contain the spread of the pandemic. As an important node of the world industrial chain, it is difficult for China to complete the production closed loop in a single link. The domestic added-value ratio of China's exports has risen from 69% in 2000 to 84% in 2019, with the domestic added-value ratio of processing trade rising from 56% to 78%. Over-reliance on overseas markets has undermined China's economic recovery.
In the face of domestic and international challenges, China proposes a new pattern of "dual circulation". Due to the obstruction of overseas markets, the new structure mainly focuses on expanding domestic demand. The pandemic has accelerated the adjustment and restructuring of the global financial, industrial and scientific systems. On the one hand, China has ensured the smooth flow of domestic industrial chains and the safety of supply chains. On the other hand, China has given full play to the central role of the capital market, helped listed companies develop and grow, and promoted a virtuous economic and financial cycle.
The companies in different life cycle stages have different risk characteristics, and different life cycle stages correspond to different financing instruments (Antoniou, Guney, and Paudyal 2008). Taking the opportunity of reforming the registration system, China has encouraged funds to enter key areas such as science and technology. The economic explanation is to give greater incentives to the human capital that contributes to the growth (Bauguess, Slovin, and Sushka 2012). China is firmly committed to the strategic goal of transforming the country from a manufacturing powerhouse to an innovation-driven economy.
4IFinancial innovation under the impact of the Covid-19 pandemic
4.1. Covid-19 as an accelerator of digital inclusive finance
This outbreak was a big test for commercial banks and further accelerated their digital transition. The pandemic has shown very well the value of contactless transactions. Covid-19 spreads through close contact. During the pandemic, it was very important to provide contactless financial services based on network channels by means of science and technology. Users’ cognition of banks has changed. The contact-free banking services were recognized by more users, and this forced banks to accelerate the use of fintech to improve relevant processes, move more businesses online, and reduce the frequency of users going to branches.
After the outbreak of the pandemic, it was obvious that the digital inclusive finance has basically satisfied the consumption needs of households, but the replacement rate of companies was not high. Despite the development of the industrial internet, in China’s current real economy, most companies invest in labour-intensive industries, which require many production lines. Many small and medium-sized enterprises still rely on manual operation. Therefore, the blocked movement of people had a huge impact on small and medium-sized companies.
The total number of individual companies in China is about 977.65 million, involving 230 million employed people, or 28.8% of the total labour force (Wang, Guo, and Li 2020). The annual trading volume is about 13.1 trillion yuan, equivalent to 34.4% of the total retail sales (Wang, Guo, and Li 2020). It can be seen that China's small and micro businesses have a large economic volume. Small and micro businesses without collateral and with greater risks often find it difficult to obtain loans from traditional financial institutions (Antoniou, Guney, and Paudyal 2008). Traditional bank valuation methods tend to pay too much attention to collateral, so financial resources habitually flow into the asset-heavy industry with a lot of collateral (Berger and Udell1990).
Big data make it possible for small and micro businesses to get more loans. More and more people are participating in the online economy, which also means accumulating broader, more diverse, and larger amounts of big data. These big data are particularly important for financial institutions. Digital images can be used to assess the risks of individuals and small and micro businesses in a more comprehensive and three-dimensional manner. The precision loans of digital financial inclusion increased 1%, the impact of the pandemic was reduced by 2.57%. The precision lending of digital financial inclusion reduced the impact of the pandemic by about 51% in China (Wang, Guo, and Li 2020).
China’s digital inclusive finance companies, especially some companies in the fields of e-commerce and digital finance, are quite prominent. During the pandemic, these new forms of companies have also played a relatively good role as macroeconomic stabilizers.
Based on the advantages of real-time trading, behavioural feature coverage, machine learning, etc., the big data have been used to replace mortgage assets for risk control, and are more accurate in predicting default rates, making inclusive finance really possible.
4.2. Supply chain finance was the key to a rapid recovery
In the context of global industrial chain layout, the shutdown of overseas upstream and downstream companies and the significant reduction of foreign trade orders have hindered the resumption of work and production. China has used various financial means to ensure the smooth resumption of work and production of upstream and downstream companies in the industrial chain, mainly by promoting supply chain finance to stabilize foreign trade.
China encourages banks to develop a supply chain business system to provide companies with supply chain financing services through a combination of online and offline approaches. Banks are encouraged to establish transaction risk control models and innovate supply chain finance models through real-time exchange of transaction data with relevant systems of government agencies and core companies.
With the spread of the pandemic overseas, the default rate of overseas orders is likely to continue to increase. China encourages insurance institutions to further expand the coverage of short-term export credit insurance and appropriately reduce the premium rate on the premise that the risks are under control. Trust and asset management companies can also purchase relevant assets related to supply chain finance from banks through ABS, trust plans and standardized notes, etc., so as to help banks spread risks and achieve a more efficient collaborative approach.
4.3. China remains committed to the reform and opening-up of its financial sector
The global pandemic has not affected the ability of China’s financial market to expand reform and opening up. The risks of various types of risky assets in the global financial market have increased recently. The monetary and fiscal policy space of each country determine the counter-cyclical ability to adjust the economy, and the economic pressure degrees of each country are also different.
China has sufficient policy tools to deal with various risks. Figure 2 shows that the too loose monetary policy in the United States has affected the status of the dollar in the world. The reasonable monetary policy of China has been conducive to promoting the internationalization of the RMB. Overseas markets also recognize the reform and opening up of China’s financial markets. For example, the MSCI index expanded its share of A-shares and the FTSE Russell includes Chinese government bonds in its index.
Figure 2. CNY-index versus USD-index
Companies involved in new economy can take advantage of the rapidly developing overseas foreign bond and stock market for Chinese companies to obtain financing in time. Especially for some medium and small-sized companies of the new economy, such as high-tech manufacturing, e-commerce, clean and renewable energy companies, issuing global bonds and stocks has positive brand effects and can reduce financing costs. It also can improve the recognition, transparency and management of emerging companies by overseas investors. With the relaxation of regulatory policies, overseas financial institutions have gradually set up subsidiaries in mainland China to enjoy the dividends of China's economic development. The focus of China's future opening-up policy should be to integrate cross-border capital channels, improve the infrastructure of the financial market, strengthen cross-border supervision and coordination, optimize the macro-prudential management system, and prevent systemic risks.
5Conclusion
The Covid-19 pandemic has had a significant impact on the original global supply chain and demand system, as well as on the economic structure of major economies. China is the first country to recover from the impact of the pandemic because of an ample policy toolbox and supply-side recovery policies. The special market environment formed in the pandemic have promoted the economy to achieve a change of growth, forcing China to establish a "dual circulation" development pattern and accelerate its digital economy.
The pandemic has also shown very well the value of contactless transactions, resulting in a big test for commercial banks and further accelerated digital transition of the traditional financial institutions. What's more, the digital inclusive finance and supply chain finance were the key to a rapid recovery. Also, China remains committed to the reform and opening-up of its financial sector. In a word, the Covid-19 pandemic has been an accelerator of economic transition and financial innovation in China.
References (Slidable)
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[3] Berger, A. N. , and G. F.Udell . 1990. “Collateral, Loan Quality and Bank Risk.” Journal of Monetary Economics 25 (1):21–42.
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Source:Journal of Chinese Economic and Business Studies, Jan 18, 2021 (Opinions stand for author's personal research view only, not for opinions of any institution)