In the first three quarters of 2003, the Chinese economy maintained the good momentum of rapid growth in spite of various difficulties. GDP increased by 8.5 percent and CPI rose by 0.7 percent over the same period of 2002.

Since the beginning of this year, money and credit increased at a fast speed. Entering May, broad money (M2) kept growing by over 20 percent. New loans extended during the first half of this year almost equaled the total amount of Year 2002. Robust growth of money and credit has strongly supported economic development. However, if nothing is done to reign in the excessive growth, it will probably further encourage duplications of constructions at low levels and exacerbate potential systemic risks, thus affecting sustainable development of the national economy.

The People's Bank of China (PBC) cherished the good growth momentum, and continued to implement the sound monetary policy. Economic means were extensively applied to control the faster than desired money and credit growth, including strengthening open market operations, raising the reserve requirement ratio by one percentage point, which ensured proper control of the fast expansion of money and credit.

In the first three quarters, broad money M2 grew by 20.7 percent over the same period of 2002 to RMB21.4 trillion yuan, while narrow money M1 grew by 18.5 percent to RMB7.9 trillion yuan. At end-September, total loans in both renminbi and foreign currencies by financial institutions (including foreign-funded ones) reached RMB16.7 trillion yuan, a growth of RMB2.7 trillion yuan over the beginning of the year and an acceleration of RMB1.3 trillion yuan over the same period of last year. In particular, renminbi loans by financial institutions grew by RMB690.5 billion yuan in the third quarter, 282.3 billion yuan less than the growth in the second quarter. Both interest rate and exchange rate of renminbi remained stable and financial industry broadly performed well.

In the coming months, the PBC will make sustained efforts and adopt a comprehensive, coordinated and sustainable development approach to maintain the sound performance of the economy. As the central bank, the PBC must be more forward-looking and scientific in the making of monetary policy and in the exercise of financial management. The sound monetary policy will continue to be implemented with flexible employment of various policy instruments to maintain the effectiveness of monetary policy seen in the first three quarters and to guide steady growth of the monetary aggregates. Interest rates of RMB deposits and loans and the money market will be kept basically stable. Market-based interest rate reform will be steadily advanced, and the interest rates formation mechanism based on market supply and demand of financial resources will be gradually established and improved. The RMB exchange rate will be maintained basically stable at an adaptive and equilibrium level. As financial reforms deepen, the mechanism for determining the RMB exchange rate will be further studied and improved to promote balance of payments equilibrium. The development of money market will be accelerated and its financing role will be enhanced. Continued efforts will be made to support the development of capital market to increase direct financing. "Window Guidance" will continue to be applied as appropriate to warn financial institutions of potential credit risks.

Part One     Monetary and Credit Performance

In the first three quarters of 2003, the performance of the national economy was broadly strong. The People's Bank of China (PBC) continued to implement the sound monetary policy, conscientiously carried out the preemptive adjustment and fine-tuning, brought into full play the dominant role of economic means in the new round of economic restructuring, and made strenuous efforts in preventing systemic financial risks. The trend of faster than desired increase of credit since the beginning of the year began to be reined in, the financial performance was broadly steady and the exchange rate of RMB remained stable.

I. Continued rapid growth of money supply

In the first three quarters, broad money M2 grew by 20.7 percent over the same period of 2002 to RMB21.4 trillion yuan. In particular, it grew 18.5 percent in the first quarter, 20.8 percent in the second quarter, and 21.6 percent by the end of August when it was at the highest level. Narrow money M1 grew by 18.5 percent to RMB7.9 trillion yuan. Cash in circulation M0 grew by 12.8 percent to RMB1.8 trillion yuan. Cumulative net cash injection during the first three quarters reached RMB102.8 billion yuan, 48.4 billion more than the same period of 2002. The growth of M2 and M1 represented an acceleration of 3.9 and 1.7 percentage points respectively over the beginning of the year, and M2 growth was 11.5 percentage points higher than the sum of GDP growth and CPI increase.

Figure 1      Quarterly Movements of Growth Rates of M0, M1 and M2 between 1998 and September, 2003

Source: PBC Quarterly Statistical Bulletin (Beginning from 2000, M2 includes margin deposits for stock trading)

II. Increase of loans by financial institutions still too fast

At the end of September, total loans in both renminbi and foreign currencies by financial institutions (including foreign-funded ones) increased to RMB16.7 trillion yuan, a growth of RMB2.7 trillion yuan over the beginning of the year and an acceleration of RMB1.3 trillion yuan over the same period of last year. In particular, renminbi loans grew by RMB2.5 trillion yuan over the beginning of the year, 624 billion yuan more than the total loan increase during the whole year 2002 and representing an acceleration of RMB1.1 trillion yuan over the same period of 2002; while foreign currency loans grew by USD23.8 billion over the beginning of the year, representing an acceleration of USD17.9 billion.

Of the increase of renmibi loans, that for the first quarter was RMB808.2 billion yuan, an acceleration of RMB475.8 billion yuan over the same period of last year; that for the second quarter was RMB972.8 billion yuan, an acceleration of RMB475.2 billion yuan. After the SARS epidemic, the PBC strengthened the adjustment and control on the total credit, and the acceleration of loans by financial institutions began to slowdown starting from the third quarter. Renminbi loans by financial institutions grew by RMB690.5 billion yuan in the third quarter, 282.3 billion yuan less than the growth in the second quarter while still representing an acceleration of RMB166.4 billion yuan over the same period of 2002. At present, the growth of loans by financial institutions is generally still faster than desired.

Figure 2      Quarterly Movements of Growth of Loans in renminbi

between 1998 and September, 2003

Source: PBC Quarterly Statistical Bulletin (Starting from 2003, loans by foreign-funded financial institutions are included.)

Box 1          Analysis of Current Loans Structure Loan structure is of great significance to economic structural adjustment. In 1998, the quota control on credit was abolished. The PBC implemented "administration of guidance planning" on loans by commercial banks. The structure and quantity of loans were determined by discretion of commercial banks in line with the laws, policy guidelines and lending principles. In recent years, the structure of loans by banks has gradually been optimized. In terms of sources of loans, loans by wholly state-owned commercial banks are still dominant. The share of those by joint-stock commercial banks and by rural credit cooperatives (RCCs) is, however, increasing gradually. At the end of 2002, shares of loans by wholly state-owned commercial banks, policy banks, joint-stock commercial banks and RCCs are 56.4 percent, 12.6 percent, 12.2 percent and 10.5 percent respectively. Of the increase of renminbi loans during the first three quarters this year, wholly state-owned commercial banks, policy banks, joint-stock commercial banks and RCCs accounted for 51.1 percent, 5.6 percent, 22.7 percent and 12.7 percent respectively. In terms of the destination flow of loans, the new loans mainly went to the five areas of loans for discounting commercial bills, loans for infrastructure and technological innovation, consumer loans, agricultural loans and short-term industrial loans, accounting for 70 percent of increase of total loans by financial institutions in the same period. The five areas of destination flow of loans generally follow the guidance of macro policies. In terms of locality structure, new loans clearly concentrate on economically developed regions. While loan growth accelerates by a big margin, the structure of loans continues to improve and efficiency of credit fund utilization is further enhanced: Firstly, loans to small- and medium-sized enterprises (SMEs) increased. According to the statistics by the PBC Credit Information Reporting System, in the first half of 2003, loans to SMEs accounted for 51.7 percent of the total loans, up 0.7 percentage points over the same period of last year. Loans for commercial bills grew immensely and became the important source of funds for SMEs. In the first three quarters, loans for discounting commercial bills grew by RMB457.9 billion yuan, representing an acceleration of RMB291.6 billion yuan over the same period of last year. During the period from January to August, cumulative amount of acceptance of commercial bills reached RMB1.7 trillion yuan, over half of which was attributed to that for SMEs. According to the surveys conducted in Beijing and Shanghai, 59 percent of commercial bills accepted was devoted to SMEs while 63 percent of the total discount loans were injected into SMEs. Loans for privately-owned enterprises and self-employed workers also grew enormously, with growth in the first three quarters standing at RMB35.2 billion yuan, an acceleration of RMB11.7 billion yuan over the same period of last year. Secondly, agricultural loans accelerated conspicuously. Cumulative agricultural loans in the first three quarters reached RMB651.5 billion yuan, an increase of RMB149.3 billion yuan or 30 percent over the same period of last year. In the third quarter, while the growth of loans slowed down, loans to RCCs continued to accelerate by a big margin, representing an acceleration of RMB47.6 billion yuan over the same period of last year. Thirdly, loan turnover sped up. In the third quarter, the turnover of loans by banks and credit cooperatives amounted to 1.02 times, 0.18 times greater, or 77 days shorter in terms of turnover period, over the same period of last year. In particular, cumulative loans to privately-owned enterprises and self-employed workers grew as fast as 82 percent, with turnover accelerated by 0.26 times or turnover period shortened by 54 days over the same period of last year. The problem for SMEs to acquire loans has furthered been eased. At present, however, there are still some problems in loan structure that deserve attention. First, mismatching of maturity structure of the assets and liabilities in financial institutions exacerbates, and potential liquidity risk becomes more prominent. In recent years, such long- and medium- term credit businesses as loans for infrastructure and individual housing loans by commercial banks developed quickly. At the end of the third quarter, the ratio of long- and medium-term loans to the total loans by financial institutions arrived at 39 percent, 18 percentage points higher over the end of 1997. Of the sources of deposits, time deposits accounted for 43 percent, 10 percentage points lower over 1997. In terms of newly-increased amounts, it became clearer that the fund sources tended to be more short-termed and fund use more long-termed. In the first three quarters, long- and medium-term loans accounted for 46 percent of all loans and time deposits for 43 percent of all deposits sources. Taking into account that a considerable part of time deposits were those with maturities less than one year, the mismatching of maturities of assets and liabilities would be more obvious. Second, real estate loans accounted for an unduly high share in the newly-increased long- and medium-term loans. In particular, increase of high-risk housing development loans was too big. In the first three quarters, various real estate loans (including housing development loans and individual housing loans) grew by RMB426.4 billion yuan, accounting for 37 percent of the total growth of all long- and medium-term loans. In particular, real estate development loans grew by RMB135.0 billion yuan, representing an acceleration of RMB100.6 billion yuan over the same period of 2002. Vigilant attention should be attached to the potential systemic credit risk in the fast growth of real estate loans, particularly real estate development loans. Third, total non-performing loans (NPLs) decreased at a slow pace while losses out of NPLs were still on the rise. It is still an arduous task to reduce NPLs, lighten the historical burden and resolve the financial risk.

III. Steady growth of renminbi deposits and slight decrease of foreign currency deposits

At the end of September, total deposits in renminbi and foreign currencies of financial institutions increased by RMB3.2 trillion yuan over the beginning of 2003 to RMB21.5 trillion yuan, representing an acceleration of RMB880.8 billion yuan over the same period of 2002. In particular, renminbi deposits increased by RMB3.2 trillion yuan over the beginning of the year, representing an acceleration of RMB946.4 billion yuan over the same period of the previous year. Foreign currency deposits dropped by USD2.56 billion (while they grew by USD5.36 billion in the same period of 2002), decelerating by USD7.92 billion over the same period of last year.

Corporate deposits and household savings deposits kept fast growth.  At the end of September, corporate deposits in renminbi and foreign currencies by financial institutions increased by RMB1 trillion yuan over the beginning of 2003 to RMB7.4 trillion yuan; household savings deposits grew by RMB1.38 trillion yuan to RMB10.8 trillion yuan. In particular, savings deposits in renminbi grew by RMB1.4 trillion yuan over the beginning of 2003, representing an acceleration of RMB344.0 billion yuan over the same period of the previous year; corporate deposits in renminbi increased by RMB1 trillion yuan, representing an acceleration of RMB374.3 billion yuan.

Figure 3      Quarterly Movements of Growth of Loans in Renminbi and Foreign Currencies by Financial Institutions since 1998

Source: Sources and Uses of Credit Funds of Financial Institutions (Starting from 2002, deposits in renminbi include those of foreign-funded financial institutions.)

IV. Rebound in growth of base money and decrease of the reserve ratio of financial institutions

At the end of September, the balance of base money of the central bank reached RMB4.6 trillion yuan, representing an increase of 16.8 percent from a year earlier, an acceleration of 4.9 percentage points from the growth rate recorded at the beginning of 2003 and one of 10.1 percentage points from that recorded at the end of June. The growth rate of base money rebounded at the end of the quarter mainly because the PBC injected some short-term liquidity as a result of the rise of demand for cash in the market during the National Day Holiday and freezing of funds for initial public offerings by Huaxia Bank etc. Meanwhile, the one percentage hike of the reserve ratio for deposits also increased some base money accordingly.

At the end of September, the reserve ratio of financial institutions averaged 3.52 percent. In particular, that of wholly state-owned commercial banks averaged 3.34 percent, that of joint-stock commercial banks 4.63 percent and that of RCCs 3.99 percent. The performance in the first three quarters indicated that the reserve ratio of financial institutions dropped. In particular, that for the first quarter stood at 5.1 percent, that for the second quarter at 3.9 percent. Financial institutions, however, held securities in renminbi worth of RMB2.8 trillion yuan, representing 18 percent of total loans in renminbi in the same period. The securities can be converted for liquidities at any time in the inter-bank market. In general, the liquidity of financial institutions was normal.

Figure 4      Quarterly Movements of Growth of Base Money and

                  Reserve Ratios of Financial Institutions since 2000

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Source: Sources and Uses of Credit Funds of Financial Institutions

V. Broad stability of interest rates and increase of interest rates in the money market

Since the beginning of this year, the official interest rates for deposits and loans prescribed by the PBC remained stable broadly. Since the interest rate cut on February 21, 2002, there was no adjustment in the official interest rates for deposits and loans by financial institutions. The current interest rate for 1-year time deposits is 1.98 percent, while that for the 1-year loan is 5.31 percent, with both at record-low levels. For large amount deposits with a maturity of 61 months, the interest rates were mainly in the range of 3.1 to 3.3 percent in the first quarter, 3.1 to 3.2 percent in the second quarter and 3.1 to 3.5 percent in the third quarter.

The interest rates for deposits and loans in foreign currencies dropped. Based on interest rates changes in the international market, the PBC lowered the interest rates for small amount deposits in foreign currencies on July 2, and the cut, in turn, brought about the decrease of interest rates of large amount deposits in foreign currencies and loans in foreign currencies. In August, the weighted average interest rate for US dollar deposits with maturities ranging from 3 months to 6 months, which held the largest share in large-amount deposits in foreign currencies, was 0.8408 percent, down 0.1108 percentage points from 0.9516 percent in June. The weighted average fixed interest rate of one-year US dollar loans was 2.4865 percent, down 0.104 percentage points from 2.5905 percent in June while the weighted average floating interest rate was 2.3563 percent, down 0.0602 percentage points from 2.4165 percent in June.

The interest rates in the money market increased. In the first quarter, the monthly weighted averages for inter-bank lending rates were 2.16 percent, 2.13 percent and 2.06 percent respectively, those for interest rates of bond repo were 2.28 percent, 2.25 percent and 2.04 percent respectively. In the second quarter, the monthly weighted averages for inter-bank lending rates were 1.98 percent, 2.02 percent and 2.11 percent respectively, those for interest rates of bond repo were 1.97 percent, 2.04 percent and 2.17 percent respectively. In the third quarter, the monthly weighted averages for inter-bank lending interest rates were 2.15 percent, 2.19 percent and 2.69 percent respectively, those for interest rates of bond repo were 2.2 percent, 2.24 percent and 2.93 percent respectively.

VI. Continuing increase of official foreign exchange reserves and stability of renminbi exchange rate

In the first three quarters of the year, the balance of payments remained broadly in strong position, with foreign exchange purchased by banks exceeding that sold in the market. At the end of September, the official foreign exchange reserves reached USD383.9 billion, up USD97.5 billion over the beginning of this year. The renminbi exchange rate remained stable, being at RMB8.2770 yuan against one US dollar.

Part Two   Monetary Policy Conduct

Robust money and credit growth since the beginning of the year has strongly supported economic development. However, it has also been noted that if nothing is done to reign in the excessive money and credit growth, it will further encourage duplications in constructions at low levels and exacerbate potential systemic risks. Therefore, the PBC took mainly economic measures to adjust and bring the excessive growth under control.

I. Sterilization operations through the open market intensified

Since the beginning of the year, serialising the base money growth resulted from foreign exchange purchase has been the focus of monetary policy operations. The PBC issued central bank bills and carried out repurchase operations to sterilise base money growth. Open market operations in Q3 were particularly challenged by complex market conditions. The RMB open market operations went through two phases. The first phase ran from early July to mid-August, during which the PBC continued to issue central bank bills, intensified its efforts to withdraw the excessive liquidity of the commercial banks, and ensured smooth growth of base money. In this phase, RMB105 billion yuan was withdrawn through open market operations. The second phase ran from end-August through end-September during which    pre-emptive operations were carried out to address the sudden liquidity demand of the commercial banks. Central banks bills issue was scaled down in a timely fashion and 7-day reverse repos were carried out to provide short-term funds for the commercial banks and alleviated their liquidity shortage. As an important component of the reserve requirement policy and necessary market arrangements, the PBC also redeemed some central bank bills at the end of September to cover the liquidity gap of some small and medium-sized commercial banks to satisfy the 7 percent reserve requirement ratio. Net release of base money in this phase was RMB91 billion yuan.

Open market operations are highly flexible in that they manifest the overall trend and stance of the monetary policy, at the same time, are able to iron out the volatilities of liquidity and financial markets from either seasonal or sporadic factors by fine-tuning the direction and intensity at a given period of time, and thus reduce the noise in the financial markets. Open market operations since late August, through the instruments and maturity structure of the operations, have made clear the intention of the central bank to maintain steady growth of base money, and at the same time, have addressed the temporary liquidity shortages caused by policy, sporadic and seasonal factors. In this flexibility and robustness lies the very life of open market operations.

Between April 22 and September 20, the PBC offered RMB545 billion yuan in 42 issues of central bank bills. Issues of 3-, 6- and 12-month maturity were RMB300 billion yuan, RMB155 billion yuan and RMB90 billion yuan respectively. On September 30, central bank bills outstanding was RMB425.43 billion yuan. In the first 9 months of the year, the PBC withdrew an accumulated RMB334.6 billion yuan of base money through open market operations and released an accumulated RMB650.5 billion yuan through foreign exchange operations, resulting in a net release of RMB315.9 billion yuan.

II. Reserve requirement ratio was raised by one percentage point

Since the beginning of the year, excessive growth of bank loans has been observed, a phenomenon related to the overall abundant liquidity in the financial system. The PBC issued central bank bills and carried out other sterilising operations. However, central bank bills are relatively short-term instruments and have their constrains in sterilising persistent growth of base money as a result of growth in foreign exchange reserves. More powerful measures were called for and a hike in reserve requirement ratio proved an effective policy measure in absorbing liquidity. In order to alleviate the pressure on central bank bills in withdrawing liquidity, and prevent excessive growth of aggregate money and credit, with the consent of the State Council, the PBC raised the reserve requirement ratio on September 21, 2003 by one percentage point, from 6 percent to 7 percent.

This latest adjustment of the reserve requirement ratio had three features. First, it was announced one month ahead of the effective day to leave enough space for liquidity management of the financial institutions. Second, one percentage point hike in reserve requirement ratio translated into freezing RMB150 billion yuan excessive reserves of the commercial banks, or 6 percent of their holdings of government securities, financial bonds and central bank bills. It proved a mild policy instruments. Third, as part of the reserve requirement policy, while appropriately tightening the aggregate, the PBC provided necessary short-term support to financial institutions with short-term liquidity difficulties and ensured overall stability of the financial activities and money market rates.

III.  Timely "Window Guidance" was offered to financial institutions

After July, the PBC summoned 3 window guidance meetings to analyse the monetary developments in 2003 and give out warnings of the possible systemic risks that could be caused by the excessive credit expansion. Financial institutions were required to uphold capital adequacy ratio, keep appropriate loan / deposit ratio and guard against the risks of investing short-term funds in long-term assets. They were also asked to strengthen their liquidity management, avoid excessive lending for the sake of artificial reduction of NPL ratio, and put appropriate control on credit aggregates.

Window guidance in general proved effective as a complementary monetary policy measure. Since July, the state-owned commercial banks have taken appropriate measures to address the excessive credit growth and adjusted their performance assessment procedures for their branches accordingly. Most joint-stock commercial banks made necessary adjustment to their credit growth as well. Between July and September, the monthly growth of credit was RMB100 billion yuan less than the average in the first half of the year.

IV. Real estate credit management was improved to support the healthy developments of the real estate sector

Real estate industry is one of the key industries of national economy. It is of utmost importance to sustain stable and healthy development of the real estate sector for the quality development of the economy. Since 1998, in accordance with the state policy, the PBC released a number of policies to support the development of the real estate sector and prevent financial risks (see Table 1).

Table 1  PBC Documents on Real Estate Credit Policy

With the support of the macroeconomic policies of the state and the incentive measures of the PBC, the real estate industry developed rapidly. Between 1998 and 2002, housing loans extended to individuals increased at an average annual rate of 112.8 percent and loans to real estate developers and construction companies grew at an average rate of 25.3 percent. The outstanding real estate loans grew from RMB310.6 billion yuan at the end of 1998 to RMB2,132.7 billion yuan at the end of September 2003 (see Figure 5). Loans to the real estate sector contributed significantly to increasing domestic demand and pulling the economic growth. Persistent rapid development of real estate credit of such magnitude was unprecedented in the world history.

Figure 5. Developments of Outstanding Real Estate Loans

          Source: PBC.

Since last year, real estate credit in some areas has shown signs of excessively rapid growth with inherent potential risks. In order to prevent boom and bust of the economy caused by sharp volatilities of the real estate sector and safeguard the financial stability, the PBC released the "Notice on Further Strengthening Management of Real Estate Credit Management" on June 5, 2003. it warned of the risks of real estate credit and stipulated in principal prudent measures for loans to real estate developers, working capital loans to construction industry and housing loans to individuals for a second (or more) home. This document helped further rectify the market for real estate credits and served as a warning signal for commercial banks against risks.

On August 12, the State Council issued the "Notice on Promoting the Sustained and Healthy Development of the Real Estate Markets". While paying tribute to the real estate industry as an important pillar of the national economy and vowing to exert more efforts in providing credit support to eligible real estate developers and projects, the document pointed out the unbalanced development of the real estate market, the marked structural problems between supply and demand in some areas, the excessively fast growth of real estate prices and investments, and the need to further improve the supervision and adjustment of the real estate markets. In order to contain and resolve risks of the real estate loans and safeguard the financial stability, it called for strengthening supervision and prohibited any unauthorised real estate loans.

The documents released by the State Council and the PBC purported to promote the sustained and healthy development of the real estate industry, prevent credit risks, and safeguard financial stability. In the future, the PBC will, according to the guidance of the State Council, continue to monitor closely asset price movements and prevent NPL growth in the real estate credit business and financial risks that may hurt the real economy. While helping to rectify the real estate markets, the PBC will, in coordination with relevant departments, develop diversified financing channels for real estate developers, including equity and project financing, to support the healthy development of the industry.

V. Support was given to the reform of the rural credit cooperatives

In June 2002, the State Council released the "Pilot Programme to Deepen the Reform of the Rural Credit Cooperatives". The main contents were on the ownership restructuring of the rural credit cooperatives, the management authority of the local governments, ownership diversification and recapitalisation of the rural credit cooperatives.

In spirit of this document, the PBC decided to provide financial support up to 50 percent of the balance sheet in solvency gap recorded at the end of 2002 to the rural credit cooperatives in the pilot programme by issuing central bank lending or bills ear-marked for this purpose. To this end, the PBC drafted the "Operational Procedures for Special Bills in the Pilot Reform Prgramme of Rural Credit Cooperatives" and the "Administrative Rules for Earmarked Financing to the Pilot Reform Prgramme of Rural Credit Cooperatives" and released to the PBC branches for implementation. Provinces participating in the pilot project can opt for one financing method or both. For example, at the county level, some counties may choose central bank lending while others prefer special central bank bills. However, the total financing should not exceed 50 percent of the insolvency gap of the rural credit cooperatives recorded at the end of 2002. These measures helped solve the historical legacy problems of the rural credit cooperatives, facilitate their healthy development and improve financial services in the rural areas.

VI. Interest rates of small deposits in foreign currencies were lowered and the transformation of postal savings into deposits was advanced

After the ECB lowered the main refinancing rate on March 6 and June 5 by 25 and 50 basis points to 2 percent, the Federal Reserve lowered the federal fund rate and the rediscount rate by 25 basis points to 1 and 0.5 percent on June 25, 2003. Lower rates ensued in the international market. With the consent of the State Council, the PBC lowered the rates of small deposits in foreign currencies on July 2, 2003. One-year US dollar deposit rate was lowered by 25 basis points from 0.8125 percent to 0.5625 percent. At the same time, the PBC further simplified the interest rate administration of foreign currency deposits. Interest rates of small deposits in pound sterling, Swiss franc and Canadian dollars were left to be decided by the commercial banks. 

With the consent of the State Council, the PBC issued the "Notice on Issues Pertaining to Interest Rates Applied when Transferring Postal Savings Deposits with the Central Bank" on September 1, 2003. It was made clear that from August 1, 2003, for new postal savings deposited with the central bank, interest rate for financial institutions accounts (currently 1.89 percent) would apply, while old deposit rate (4.131 percent) would continue to apply for the stock of deposits before the date. At the same time, from August 1 on, postal savings institutions would be allowed to take discretions in the use of any new postal savings, including securities trading in the inter-bank market, putting large deposits with negotiated rates with Chinese commercial banks and rural credit cooperatives, business cooperation with policy banks, offering fee-based services and underwriting state bonds and financial bonds issued by policy banks. This reform would encourage more funds to stay in the rural area to support the rural economic development.

VII. Close monitor of the exchange rate movements of major currencies and efforts to maintain RMB stable

Since the beginning of the year, the balance of payments has been in surplus. Current account surplus moderated but capital account surplus increased significantly. Against this background, the PBC adopted a number of measures to maintain RMB exchange rage stable and the BOP in balance. First, the standpoint of keeping the RMB exchange rate stable was insisted. Second, demand and supply of foreign exchange was reviewed to facilitate BOP development in balance. Third, open market operations were conducted to sterilise the base money increase resulted from foreign exchange rise. Fourth, RMB exchange rate and developments in the international exchange markets were closely monitored.

In order to promote a balance development of the BOP, the PBC released a number of measures to extend the access to foreign exchange by individuals and enterprises. They include, reforming the current account administration and allowing enterprises to retain more foreign exchange, simplifying the verification procedures for export and import documentations to facilitate foreign trade, reforming the administration on non-trade foreign exchange purchases and sales of multinational companies to facilitate their business activities, lifting the limits for individuals to buy and carry foreign currencies when travelling abroad, and carrying out pilot programme on foreign exchange administration of overseas investment to widen channels for outward capital flows.

Part Three       Financial Market Performance

{C}I.        Rapid growth of inter-bank borrowing market turnover

The first nine months of 2003 witnessed active transactions in inter-bank borrowing market, with accumulated turnover of inter-bank borrowings totaling RMB1811.3 billion yuan, a growth of RMB972.2 billion yuan or 1.2 times over the corresponding period of 2002, and an acceleration of RMB600.6 billion yuan over the total of 2002. 

With respect to flow of funds in inter-bank borrowing market, the state-owned commercial banks as a whole remained the largest net providers of funds, and the recipients of funds were securities firms, fund management companies, associations of rural credit cooperatives, policy banks, finance companies, trust and investment companies and foreign financial institutions. With respect to the weight of different fund recipients in net borrowings, the share of securities firms and fund management companies climbed at a faster pace than a year ago.

Table2   Fund Flow of Financial Institutions in Inter-bank Borrowing Market

                                                                                           RMB 100 million yuan                       

Note: 1. "-" means net outflow;

2. Other commercial banks include joint stock commercial banks and city commercial banks.

Source: PBC China Financial Market Monthly Statistical Bulletin.

Between January and September of 2003, the monthly-weighted average interest rate in inter-bank borrowing market declined from 2.16 percent in January to 1.98 percent in April, then rebound to 2.19 percent in August. In September, the interest rate climbed further to 2.69 percent, thus marking a growth of 0.46 percentage points over its level at the end-2002.

{C}II.      Smooth issuance of securities and active secondary market  

1.  Smooth issuance of securities

The first nine months of 2003 saw a total of RMB432.05 billion yuan worth of government securities issued, a decline of RMB18.38 billlion yuan or 4.1 percent from the same period of 2002. Among the new issues, RMB170 billion yuan were bearer's treasury bonds, up 37.7 percent, and RMB262.05 billion yuan were book-entry treasury bonds, down 19.8 percent or RMB64.88 billion yuan. During the same period, a total of RMB310 billion yuan woth of policy financial bonds were also issued, RMB92.5 billion yuan or 42.5 percent more than that of a year earlier. In addition, a total of RMB14.9 billion yuan worth of corporate bonds were issued, RMB0.6 billion yuan or 3.9 percent less than that of a year earlier.

During the first nine months of 2003, the issuing rates of government securities remained basically unchanged, with the rate of three-year securities standing at 2.32 percent, of five-year securities moving within the range of 2.53-2.63 percent, and of seven-year securities standing at 2.66 percent. The rate of ten-year securities registered at 2.8 percent in the first six months and climbed to 3.02 percent in September consistent with the general movement of interest rates in the market.   

In the meantime, the issuing rates of policy financial bonds moved first downward and then upward. In January, the interest rate of ten-year bonds issued by China Development Bank stood at 3.39 percent. Affected by the downward movement of interest rates in the market, the rate of policy financial bonds slid all the way in March and April. Eventually, the rate of ten-year bonds issued in April was lowered to 2.45 percent. Starting in May, the upward movement of interest rates in the market led to a steady rise in the issuing rate of policy financial bonds. Consequently, the rate of ten-year bonds issued in June rebound to 2.47 percent, then further rose to 2.77 percent in July and August. In September, the rate of 10-year bonds issued by China Development Bank registered at 3.89 percent.

2.     Active inter-bank bond transactions

The first nine months of 2003 also saw active transactions in inter-bank bond market, with accumulated turnover of bond transactions amounting to RMB11 trillion yuan, a growth of RMB3.2 trillion yuan or 40.3 percent over the same period of 2002. In particular, the turnover of outright transactions increased by RMB1.9 trillion yuan or 5.5 times to RMB2.3trillion yuan, and the turnover of bond repurchase grew by RMB1.300 trillion yuan or 16.8 percent to RMB8.8 tiillion yuan. In consequence, the liquidity of inter-bank bond market was enhanced markedly.

Table 3  Fund Flow of Financial Institutions in Inter-bank Bond Market

RMB 100 million yuan                       

Note: 1. "-" means net outflow.

Source: PBC China Financial Market Monthly Statistical Bulletin.

With regard to flow of funds in inter-bank bond market, the state-owned commercial banks as a whole were the main providers of funds, and the principal recipients of funds were other commercial banks and other financial institutions. With respect to the weight of different fund recipients in net borrowings, the share of other commercial banks rose at a quicker pace than a year ago.

Between January and September of 2003, the monthly weighted average interest rate of bond repurchase in inter-bank market also moved first downward then upward. The interest rate of bond repurchase declined from 2.28 percent in January to 1.97 percent in April, then rebound to 2.24 percent in August. In September, the monthly weighted average interest rate of bond repurchase further rose to 2.93 percent, 0.62 percentage points over the level at end-2002.

Figure 6  Movement of Monthly Weighted Average Money Market Interest Rates

Source: PBC China Financial Market Monthly Statistical Bulletin.

Box 3                 Money Market Interest Rates The money market interest rates serve as the indicators of supply and demand of funds as well as the creditworthiness of market players in money market. In China, the interest rates of the kind mainly include those of bond repurchase and inter-bank borrowings. Starting on June 1, 1996, the People's Bank of China lifted the restriction on the ceiling of inter-bank borrowing rate movement. When the inter-bank bond market was formed in 1997, the bond repurchase rate and price began to be completely decided by market supply and demand. At present, the market-based interest rate system has basically taken into shape in China's money market. Over the years, the movement of interest rates in China's money market has borne following features. First, since bond repurchase is a short-term funding with bonds as pledge and is less risky than the credit-based borrowings, its interest rate is generally lower than that of borrowings when financial institutions with same creditworthiness are concerned. Second, as financial institutions are significantly different in type, nature and creditworthiness, their interest rates for borrowing differentiate. In general, the movement of borrowing rates for state-owned commercial banks and large financial institutions is relatively stable, while that for financial institutions with poorer asset quality is volatile. Third, because bond repurchase is relatively less risky, and market players engaging in bond repurchase are mainly concerned about market supply and demand, the interest rates spread for bond repurchase by different types of financial institutions is not significant. Consequently, the repurchase rates serve as a barometer of market liquidity as well as supply and demand of funds. Over recent years, the movement of money market interest rates has been generally stable despite the trend of edging downward. However, It should be noted that during the period of every New Year and Spring Festival, the interest rates in money market had been inevitably driven higher by the tight cash position in money market. It was also the case this year. However, starting in late August of 2003, the interest rates in money market rose at a quickened pace. Between August 23 and September 30, the inter-bank borrowing rate climbed by 45 basis points from 2.26 percent to 2.71 percent, while the bond repurchase rate rose by 97 basis points from 2.27 percent to 3.24 percent. The accelerated growth of interest rates in money market stems from a number of reasons. First, whenever the government introduces a macro- economic policy, it will take some time for commercial banks to restructure their asset portfolio accordingly. Therefore, when the People's Bank of China's announced, on August 23, 2003, to raise the reserve requirement ratio from 6 percent to 7 percent effective on September 21, some commercial banks came to experience a tightened liquidity and a lower ratio of excessive reserves, as these banks, who lacked a proper composition of assets and liabilities, had experienced a rapid growth of lending activities and needed some time to adjust their asset portfolio. Second, as the People's Bank of China kept the growth of base money at a low level of 6.7 percent by using pre-emptive adjustment and fine tuning leverage, some commercial banks expanded their lending facility by cutting down the ratio of excessive reserves. Consequently, when the People's Bank of China raised the ratio of required reserves by 1 percentage point, the commercial banks with an already low ratio of excessive reserves inevitably ran tight cash position. Third, some financial institutions used short-term capital from repurchase transactions to extend loans or purchase bonds. Such behavior led to a high leverage ratio, and consequently a structural tightening of liquidity. Fourth, the changes in the way of conducting the IPO resulted in a substantially increased demand for bank liquidity. Since on-line subscription was again applied to issue the IPO, commercial banks had to keep sufficient liquidity to ensure adequate funding for the IPO. Under this circumstance, even the commercial banks with adequate capital position had to guard against the liquidity drain by adopting prudent strategies for liquidity management. Fifth, there has been a surge in subscription for bonds, which amounted to over RMB200 billion yuan in August and September of 2003. With money market being improved, financial institutions will become more sensitive to the movement of money market interest rates, which has increasingly served as the barometer of market liquidity. Although the credit quota control and other administrative measures adopted in the past makes it easier to achieve the targets for macro-control over lending activities, it is also possible that economic activities are brought to a sharp halt because of these measures. Therefore, since the beginning of this year, the People's Bank of China, in view of the rapid growth of money supply and credit, has employed various policy instruments including reserve requirement ratio and open market operations to exercise indirect control, thus avoided the occurrence of the sharp halt effect of monetary policy. However, the increase of reserve requirement ratio by one percent has tightened the liquidity of financial institutions, driving money market rates higher and bond prices fluctuating in pace with the movement of interest rates in market. Nevertheless, in comparison with the problems brought by the previous macro-control measures, the cost of indirect control is relatively small. In fact, the movement of money market interest rates is the inevitable result of the macro-control by using economic leverages, and in general has been in an acceptable range. Since 1996, China has cut the interest rates for eight consecutive times. As a result, the interest rate of one-year deposits was lowered by over 100 basis points from 10.98 percent to 1.98 percent, and such adjustment range was much higher than that of rise of money market interest rates. In the meantime, the yield of bonds also declined markedly. For instance, the coupon rate of ten-year book-entry treasury bonds issued in 1996 was 11.83 percent, while that of 30-year treasury bonds issued in 2002 was only 2.9 percent. It is a common phenomenon in market economies that the interest rates in money market are constantly changing, and the central bank strives to achieve monetary policy targets through adjustments of the rates. Take the Federal Reserve System of the United States (the Fed) for example, between June 30, 1999 and May 16, 2000, the Fed raised the federal funds rate on six occasions by altogether 175 basis points from 4.75 percent to 6.5 percent. Then since the beginning of 2001, the federal funds rate has been cut down 13 times by altogether 550 basis points from 6.5 percent to 1 percent. The change of federal funds rate was accompanied by a corresponding movement of the interest rates in money market. At present, Chinese financial institutions are more sensitive to the rise of interest rates in money market, and the Chinese market is more efficient in funds allocation. The appropriate change of money market interest rates not only serves as a barometer of supply and demand of funds, but also benefits financial institutions in strengthening liquidity management and avoiding blind expansion of lending activities. It should be noted that rapid growth of interest rates has some negative impact, including, for instance, leading to short- term foreign capital inflow. Against this background, the People's Bank of China will continue to conduct real-time monitoring of money market rates, and apply various policy instruments such as open market operations to adjust the liquidity of financial institutions and safeguard the stable movement of money market rates in line with money and credit growth.

{C}III.    Rapid expansion of bills market

Between January and July, 2003, the accumulated amount of bank acceptance (BA) issued by corporate entities was RMB1476.4 billion yuan, marking a growth of RMB650.2 billion yuan or 78.7 percent over the same period of 2002, and the accumulated amount of bills discount and rediscount totaled RMB2335.5 billion yuan, a growth of RMB1236 billion yuan or 110 percent. At end-July, 2003, the outstanding balance of BA issued was RMB1093 billion yuan, up RMB509.2 billion yuan or 87.2 percent on a year-on-year basis, while the outstanding balance of bills discount and rediscount amounted to RMB831.8 billion yuan, up RMB408.9 billion yuan or 96.7 percent. The rapid expansion of commercial bills market has contributed to an efficient allocation of financial resources, and helped alleviate the financing difficulty faced by small- and medium-sized enterprises.

IV. Steady operation of stock market

The stock market turnover in the first nine months of 2003 remained basically unchanged in comparison to that of a year earlier. The combined turnover of Shanghai and Shenzhen stock exchanges totalled RMB2347.5 billion yuan, increasing by RMB20.5 billion yuan over the same period of 2002, while the daily turnover averaged at RMB13.04 billion yuan, down RMB180 million yuan or 1.4 percent from a year earlier. The accumulated turnover of A share market alone swelled by RMB44 billion yuan to RMB2297.1 billion yuan, while its daily average turnover declined by RMB40 million yuan or 0.3 percent to RMB12.76 billion yuan.

In the first five months of this year, both Shanghai and Shenzhen stock markets edged upward in fluctuations. At end-May, the Shanghai Composite Index closed at 1576, up 218 points or 16.1 percent from that of end-2002, while the Shenzhen Composite Index closed at 441, up 52 points or13.4 percent. In June, both stock markets slid downward. At end-September, the Shanghai Composite Index closed at 1367, down 13.3 percent or 209 points from end-May, while the Shenzhen Composite Index closed at 375, down 15 percent or 66 points.

Figure 7   Closing Index of Stock Market at Month End

Source: PBC China Financial Market Monthly Statistical Bulletin

In the first nine months of 2003, the corporate sector raised an aggregate of RMB65.8 billion yuan in stock market, down RMB3.2 billion yuan or 4.6 percent from the same period of 2002. The total amount raised in A share market (including IPO, and rights and additional share issues) was RMB44.6 billion yuan, down RMB3.5 billion yuan or 7.3 percent, and the funds raised in H share market amounted to US$1.019 billion, up US$751 million or 2.8 times, and the convertible bonds issued totaled RMB12.7 billion yuan, up RMB10 billion yuan or 3.7 times.

Table 4:Financing in Domestic Financial Market

	Annual newly increased financing (RM B 100 miillion yuan)				Share（%）
	First nine months of 2003	First nine months of 2002	2002	2001	First nine months of 2003	First nine months of 2002	2002	2001
Total	29734	16978	23976	16555	100.0	100.0	100.0	100.0
Bank loans	26687	14021	19228	12558	89.8	82.6	80.2	75.9
Government bonds	2240	2112	3461	2598	7.5	12.4	14.4	15.7
Corporate bonds	149	155	325	147	0.5	0.9	1.4	0.9
Stocks	658	690	962	1252	2.2	4.1	4.0	7.6

Source: Statistics Department, PBC

In the first nine months of 2003, the funds newly raised by the non-financial sector (including households, enterprises and government agencies) in China in the form of bank credit, stocks (negotiable stock only), government securities and corporate bonds aggregated RMB2.970 trillion yuan (in both local and foreign currencies), up RMB1.270 trillion yuan or 75.1 percent from a year earlier. The proportion of financing through bank credit, government securities, corporate bonds and stocks stood respectively at 89.8 percent, 7.5 percent, 0.5 percent and 2.2 percent.

V{C} . Sound growth of insurance market

Insurance market in China continued to develop steadily in the first nine months of 2003 in terms of both insurance of persons and property insurance. Between January and September, 2003, the aggregate premium income of insurance companies in China totaled RMB296.8 billion yuan, increasing by 31.2 percent over the same period of 2002, of which the income generated by property insurance grew by 11.7 percent to RMB67.2 billion yuan, by insurance of persons grew by 38.2 percent to RMB229.6 billion yuan. As of end-September, 2003, the aggregate assets of insurance companies totaled RMB832.7 billion yuan, rising by 28.2 compared to the level at end-2002 percent and 39.3 percent from end-September of 2002. Among the total assets, bank deposits amounted to RMB383.2 billion yuan, rising by 26.6 percent and 42.8 percent respectively, while the investment amounted to RMB354.7 billion yuan, growing by 41.6 percent and 53.6 percent respectively.

In addition to the expansion of sales volume, the insurance market bore the following features in the first nine months. First, insurance companies applied a larger variety of channels for investment with their disposable funds. Insurance companies began to expand their investment to all corporate bonds with AA rating or above from confined to four industrial sectors (three gorges construction, power plants, railways and mobile communication) in the past, while the share of funds for investment in total assets raised from less than 10 percent to 20 percent. Second, the number of market players grew as insurance companies and intermediary institutions specialized in insurance opened more branches and subsidiaries, which fostered competition in insurance market. Third, the category of insurance products further expanded, and corporate pensions, health insurance and agriculture insurance activities continued to grow. Forth, insurance market was further opened to outside.

VI. Notable growth of Inter-bank foreign exchange transactions

Due to such factors as rapid expansion of foreign trade, growing spread of US dollar interest rates at home and abroad, and fluctuations of interest rate spread of local and foreign currencies, inter-bank foreign exchange transactions grew markedly in the first nine months of 2003. As a result, the accumulated turnover of inter-bank foreign exchange market increased by US$30.94 billion from a year earlier to US$96.19 billion, which was very close to the level of RMB97.19 billion yuan in the whole year of 2002. The average daily turnover increased by 45.8 percent to US$506 million. In particular, the turnover of transactions in US dollar was US$93.82 billion with the daily turnover averaging at US$494 million, up 45.3 percent over a year earlier.

Part Four   Analysis of Macroeconomic Developments

I. The World Economy was improving as a whole

1. The world economy saw marked signs of recovery

Since the conclusion of the US-led war on Iraq and the control of SARS epidemic, uncertainties surrounding the world economy growth have gradually waned. Major industrial countries such as the US saw marked signs of recovery, and the Asian countries continued to maintain strong growth. Affected by weak economic performance, trade protectionism was resurfacing in major industrial countries, and international trade was going through a low level of recovery.

The US economy recorded strong growth. The quarterly adjusted real GDP growth was 1.4 percent and 3.3 percent for the first and second quarters respectively, expected to exceed 4 percent for the third quarter. CPI growth averaged 2.9 percent, 2.1percent 2.2 percent over the same period of the previous year for the first three quarters respectively. The unemployment rate reached 5.8 percent, 6.2 percent and 6.1 percent for the first three quarters respectively. The quarterly adjusted goods and services deficit declined for the fifth consecutive month to USD39.2 billion at end-August 2003 from USD43 billion at end-March 2003.

The Japanese economy performed better than expected. The real GDP grew by 2.9 percent and 3 percent respectively in the first and second quarter. The year on year increase of CPI averaged minus 0.2 percent. The unemployment rate was 5.4 percent on average, falling to 5.1 percent in August, and a lowest level in the past two years. The ratio of current account balance to nominal GDP rose to 3.5 percent at end August from 2.4 percent at end-2002.

Economic performance in the euro zone picked up in the third quarter, although the recovery lagged behind the US and Japan. The real GDP expanded by 0.8 percent and 0.2 percent year on year in the first and second quarters respectively, whereas the quarterly growth was 0 and minus 0.1 percent respectively. CPI rose by 2.3 percent and 1.9 percent respectively over the same period of the previous year. The unemployment rate remained at the relatively high level of 8.7-8.9 percent. The export growth weakened with the quarterly adjusted current account deficit dropping to zero in July.

The developing economies were in good shape as a whole. In the first quarter, major emerging market economies maintained relatively strong growth momentum. In the second quarter, affected by the war in Iraq and the outbreak of SARS epidemic, economic growth of some East and South-east Asian emerging economies slowed down markedly, even turning to negative growth. Some emerging market economies in Latin America and Europe also showed obvious trend of slowing down. Major transition economies in Central and Eastern Europe still maintained sound growth momentum. In the second half of 2003, with the conclusion of the war in Iraq and effective control of SARS epidemic, most unfavorable factors affecting emerging market economies' growth have been eliminated, posing positive impact on the growth prospects of developing countries.

2. Major equity markets continued to rebound and the US dollar depreciated again

After the sharp decline in the first quarter, global equity markets have continued to rebound since the second quarter. Before the outbreak of the war in Iraq, uncertainties and pessimistic expectations led to the wide and continuous decline of global equity market. After the end of the war, global markets began to bounce back. On September 30, the Dow Jones and NASDAQ indices rebounded by 11.2 percent and 33.5 percent respectively over the end of the previous year and the Nikkei, 225 Frankfurt DAX, FT100 and Paris CAC40 indices regained 19.1 percent, 12.6 percent, 3.8 percent and 3.9 percent respectively.

The US dollar depreciated by a large margin again. Before the outbreak of the war in Iraq, the exchange rate of the euro against the dollar hovered between 1.04 and 1.08n dollar per euro, and the rate of the dollar against the yen stood at 116-121 yen per dollar. After the outbreak of war, the dollar rebounded somewhat, but quite weakly. Beginning from early May, the depreciation of the dollar worsened off with the rate reaching the lowest level on May 27: 116 yen and 0.838 euro per dollar. Then the dollar edged up for a time. However, as of end-September, the dollar depreciated by a large margin again. The rate of the dollar against the yen and the euro dropped to 110.23 yen and 0.8564 euro per dollar (1.1677 dollar per euro) on September 30.

3. Major economies maintained accommodative monetary policy

Since the beginning of this year, most countries have adopted accommodative monetary policies. With a view to stimulating economic growth, the US took the lead in cutting the interest rate from 1.75 percent to 1.25 percent in November 2002, triggering a round of interest rate cut wave in developed economies. The European Central Bank cut interest rate three times within the period of less than one year to 2 percent from 3.25 percent by a large margin of 1.25 percentage points. The Bank of England cut interest rate twice to 3.5 percent from 4 percent by 0.5 percentage points. The Fed further lowered interest rate by 0.25 percentage points to 1 percent in July 2003. The Bank of Japan eased monetary stance many times to increase market liquidity substantially. In late August sharp rally in Japan's stock market led investors to withdraw funds from treasury bond market, resulting in marked decline in the price of long-term treasury bonds and the corresponding rise of long term interest rates that drove the rise of short tem interest rates. Against this background, the Bank of Japan injected base money up to a total of JPY1 trillion through five operations in a bid to keep the short-term interest rate level at zero.

4. The external environment of China's economic growth improved somewhat

With the conclusion of the war in Iraq and effective control of SARS epidemic, the world economy showed marked signs of recovery in the second half of 2003. The external environment for China's economic growth improved accordingly. External trade improved markedly with the demand in the international markets, especially Middle East and Latin American markets for China's good quality and reasonably priced new products increasing. Inbound and outbound tourism recovered fast. Thanks to communications between China and the international community on both bilateral and multilateral occasions, more and more insightful people began to review China's exchange rate policy in the context of global economy and extended their understanding and support for the RMB exchange rate policy.

II. The Chinese economy continued to grow rapidly and the issues concerning sustainable development deserve close attention

In the first three quarters, the Chinese economy maintained the good momentum of rapid growth. Nonetheless, some problems arose in construction of development. In the first nine months, GDP reached RMB7911.4 billion, up 8.5 percent over the same period of the previous year. CPI rose by 0.7 percent over the same period of 2002.

1.      Strong growth in fixed asset investment was the major driving force for the rapid economic growth this year

In the first three quarters consumption demand remained stable, the growth of net exports slowed and investment demand became the most important factor driving the rapid economic growth, among which fixed investment amounted to RMB3.4 trillion, up 20.5 percent or accelerating by 8.7 percentage points over the same period of the previous year. Given the low prices of capital goods, the real investment growth adjusted by inflation was only second to the period of 1992-1993, making this year one of the fastest growing period in history.

Table 5: Financing Sources of Fixed Investment

In percent

Source: The National Bureau of Statistics

Note: Urban and rural collective investment and individual investment are excluded from capital construction, technological upgrading and transformation and other investments.

The strong fixed investment growth showed three striking features. Firstly, industrial investment far overgrew investment in other sectors. In the first three quarters, industrial investment that accounted for 34 percent of state-owned and other types of fixed investment grew by 49 percent or an acceleration of 24 percentage points. Secondly, real estate development investment increased by a large margin in terms of both absolute amounts and its share in total investment. In the first three quarters, the property development investment increased by 33 percent, accelerating by 3.4 percentage points over the same period of the previous year. Its share in the state-owned and other types of investment reached 25 percent, up 4 percentage points over the same period of the previous year. In the first eight months, out of 31 provinces in China, eight provinces witnessed real estate investment growth over 50 percent. In some provinces the growth was even near 90 percent. The real estate investment structure was to be rationalized. Residential house investment increased by 28 percent, of which affordable houses increased by 11.3 percent. The investment in office buildings and commercial property increased by 39.8 and 44.6 percent respectively. Thirdly, out of the financing source of fixed investment bank loans registered high growth and ranked first in the external financing sources with the growth rate in the first eight months exceeding 50 percent.

Consumption demand recovered to the level before the outbreak of SARS epidemic by and large. In the first three quarters, retail sales of consumer goods amounted to RMB3.3 trillion yuan, up 8.6 percent or decelerating by 0.1 percentage points over the same period of the previous year. In the first half of 2003, affected by the outbreak of SARS epidemic the consumption demand that used to remain stable declined sharply. In May, retail sales of consumer goods grew by 4.3 percent over the same period of the previous year, half of the growth rate for the same period in 2002. In the second half of 2003, consumption growth began to rebound with retail sales of consumer goods expanding by 9.8 percent, 9.9 percent and 9.5 percent respectively in July, August and September, higher than the growth rate of the same period of the previous year for all the three months.

2.      Both imports and exports maintained rapid growth and the trade surplus shrank

Since the beginning of 2003, both imports and exports maintained rapid growth in China. In the first three quarters the total volume of imports and exports amounted to USD606.3 billion, up 36 percent over the same period of the previous year. Exports reached USD307.7 billion, up 32 percent and imports reached USD298.6 billion, up 40.5 percent. The accumulative trade surplus was USD9.1 billion, down by nearly USD11 billion from the same period of the previous year, a lowest level in recent years.

China's multilateral trade ran with a basic balance on the whole. In terms of the geographical breakdown of trade balance, the bilateral trade imbalance between China and major trading partners was prominent. The trade surplus against the US rose to USD40.9 billion from USD30.4 billion and the surplus against European Union rose to USD11.1 billion from USD5.6 billion. However, the trade deficits against Asian countries and regions such as Japan, ASEAN and Taiwan continued to expand. In the first three quarters China's trade deficit against Japan widened to USD11.7 billion from USD4.2 billion and the deficits against ASEAN scaled up to USD11.8 billion from USD5.1 billion.

3.      High industrial growth was the major aspect of the current rapid economic growth

Since the beginning of the year, the share of industrial value added in GDP climbed continuously. In the first quarter, value added by statistically large industrial enterprises increased by 17.2 percent, accounting for 35 percent of GDP for the period. In the second quarter the value grew by 15.2 percent, accounting for 37 percent. In the third quarter the figure grew by 16.6 percent, accounting for 37 percent or up 6 percentage points over a year earlier. According to the estimates of the National Bureau of Statistics, in the first three quarters industries contributed 5.5 percentage points to GDP growth, accounting for 65 percent.

In terms of the nature of enterprises, the production of share-holding and foreign funded enterprises accelerated continuously and the production of state-owned enterprises remained stable. The value added by share-holding enterprises, foreign, Hong Kong, Macao and Taiwan funded enterprise, and state-owned and state-controlled share-holding enterprises increased by 17.9 percent, 19.6 percent and 14.3 percent respectively during January-September.

The link between sales and industrial production was sound and the overall economic returns continued to improve. During January-September sales ratio of industrial products hit 97.67 percent, up 0.11 percentage points compared to the same period of the previous year. During January-August, the comprehensive index of industrial economical returns reached 141.3, up 15.4 points over the same period of 2002 and net profits of industrial enterprises amounted to RMB501.5 billion yuan, a year-on-year increase of 52.3 percent. On the other hand, stocks of finished goods and accounts receivable rose by 11.4 percent and 13 percent respectively, both accelerating by 9 percentage points over the same period of the previous year.

4.      CPI edged up slightly and PPI rose by an increasing margin

In the first nine months, CPI rose by 0.7 percent over the same period of the previous year in China. Small rally of CPI was mainly attributed to rise in prices of food and some service items, while the swing in food prices was caused by seasonal factors and some external shocks such as the SARS outbreak and natural disasters. According to the estimates of the NBS food prices in China rose by 2.2 percent, contributing 0.7 percentage points to the rise of overall price level. In particular after the SARS epidemic the overall CPI rebounded gradually, with monthly increase of 0.7 percent and 1.2 percent in August and September respectively. In September food prices rose by 3.2 percent and 2.7 percent respectively compared to the same period of the previous year and the month earlier.

Driven by fixed investment and strong economic growth, China's producer prices, fixed investment prices and real estate prices rebounded quickly. In the first three quarters factory prices of industrial products rose by 2.4 percent over the same period of the previous year with the rise hitting 3.6 percent, 2.3 percent and 1.4 percent respectively in the first, second and third quarter. Among major products, crude oil price rose by 24.9 percent and steel products price continued to rise with the prices of middle-thick steel plank, thin steel plank, wire and regular middle steel products climbing by 20.3 percent, 13.1 percent, 14.3 percent and 13.7 percent respectively. The purchasing prices of raw materials, fuel and power rose by 4.5 percent and the figure was 4.6 percent, 4.7 percent and 4 percent in the first, second and third quarter respectively. Enterprise commodity price index monitored by the People's Bank of China showed the same trend of developments. In the first nine months, enterprise commodity price rose by an accumulative of 1. 37 percent on average over the same period a year earlier. The prices of investment products rose by 2.14 percent whereas the prices of consumer products fell by 0.44 percent. In September the enterprise commodity prices rose by 2.7 percent over the same month of 2002 with the prices of investment products and consumer products climbing 2.7 percent and 0.96 percent respectively.

Figure 7  Price Developments

Source: National Bank of Statistics; Statistics Development of PBC

Fueled by rapid growth of fixed asset demand the price of fixed investment jumped by 1 percent in the first half of 2003 as opposed to zero growth in the first half of 2002. The real estate price rise this year was markedly larger than the previous year. The land transaction price index reached 8.5 percent, 7.1 percent and 8.8 percent in the first, second and third quarters, up 0.6 percentage points, 1.7 percentage points and 2.5 percentage points over the same period of the previous year respectively. The house sales price index was 4.8 percent, 4.9 percent and 4.1 percent in Q1, Q2 and Q3, up 0.5 percentage point, 1.3 percentage points and 0.1 percentage points over the same period of 2002 respectively. The house rent index was 1.7 percent, 1.9 percent and 1.8 percent in Q1, Q2 and Q3, up 0.5, 0.8 and 0.7 percentage points respectively over the same period of the previous year.

Appropriate control of money and credit growth helps to guard against both inflation and deflation. In view of the current quick rebound of producer price, fixed asset investment price and real estate price, efforts shall be made to forestall the risks of overly rapid rise of asset prices that may bring asset "bubble". In the context of weak final demand coupled with oversupply of middle products, high growth of money and credit is likely to put more strains on the oversupply.

III. The performance of major industries was sound, but duplicated and low level constructions in a few sectors resurfaced

In the first three quarters of 2003, the primary, secondary and tertiary industries gained 2.8 percent, 11.8 percent and 5.4 percent respectively. Breaking down by sectors, the first nine months saw accelerated growth of the heavy industry versus slowing growth of the light industry. The heavy industry expanded by 18.4 percent or an acceleration of 6.1 percentage points. On the other hand, the light industry grew by 13.9 percent, accelerating by 1.9 percentage points. The structure of rapid growth in the heavy industry vis-à-vis slow growth in the light industry showed fast expansion of demand for producer materials, which formed a sharp contrast to the situation around 1999 when domestic demand was weak and the production of the heavy industry lagged behind the light industry.

Out of 39 industries, seven industries including the petro-chemical industry, machinery, light industry, power, electronics, textile and construction materials held important places. In the first seven months, the gross industrial output, export delivery and profits of the seven industries accounted for 84 percent, 92.9 percent and 79.3 percent of the total respectively. In terms of gross output, machinery and electronics industries outgrew the national average by 7.8 percentage points and 5 percentage points respectively, marking the fastest growth among all the industries. The export delivery of seven big industries accelerated as a whole, in particular the power and electronics industries enjoyed a growth of 43 percent and 36 percent respectively.

In terms of economic returns, 38 out of 39 industries posted increased profits in August compared with a year earlier. The net profits amounted to RMB501.5 billion yuan, up 52.3 percent over the first eight months of the previous year. The five industries that witnessed the largest increase of profits were oil and natural gas exploitation, transportation equipment manufacturing, ferrous metal smelting, mangling and processing, chemical raw materials and chemical products manufacturing and generation and supply of electricity and heat. Three industries, i.e. the petro-chemical industry, construction materials and machinery witnessed profit growth of over 60 percent. During January-August, the losses made by enterprises reached RMB79.1 billion yuan, down by 5.3 percent compared to the same period of the previous year. However, the losses made by three industries including electronics, power and light industries increased slightly against general reduction of losses by industrial enterprises.

Box 4    Maintain Comprehensive, Coordinated and Sustainable development of the National Economy In recent years the Chinese economy has maintained rapid development. We need to cherish this sound growth momentum and make efforts to maintain comprehensive, coordinated and sustainable development of the national economy. To this end, special attention should be paid to various imbalances arising from macro-economic development and to eliminate those imbalances in a timely manner. At present, imbalances in China's macro-economic development are mainly reflected in the disparities between investment and consumption, between urban and rural development and between different regions and sectors. With respect to investment and consumption the former far outgrew the latter. Although China's investment rate has stood at a relatively high level for a long period, it showed the trend of further rising in the last two years. China's consumption rate was 58.2 percent in 2002, much lower than the average level of developed countries at 78 percent and the average level of developing countries at 74 percent. In the first three quarters of this year retail sales of consumer goods increased by 8.6 percent, whereas fixed asset investment grew by 30.5 percent, thus further widening the growth gap between investment and consumption. In terms of urban and rural development, the urban area developed much faster than the rural area and income of urban residents were much higher than that of rural residents. In 2002, 50 percent of China's labor force were engaged in agricultural production, while only accounted for 15.4 percent of GDP. Overall productivity per capita was RMB14, 211 yuan, but the per capita productivity of the primary industry was only RMB4, 371 yuan. The per capita income gap between urban and rural residents hit 3.2 times. In addition, there existed big differences between the urban and rural residents in terms of residence registration, employment, medical care, pension, food supply and housing system. In terms of regional development the eastern region developed much more rapidly that the middle and western regions of China. GDP of the east, middle and west part of China reached RMB7074.4 billion yuan, RMB3138.5 billion yuan and RMB1589.1 billion yuan respectively in 2002, with the gap between the eastern and the middle region, the middle and western region further widening compared with 1999. Per capita GDP in the eastern region reached RMB16, 490 yuan in 2002, more than doubled the national average. In contrast, the figure in the middle and western regions was 12 percent and 30 percent respectively lower than the national average. Furthermore, imbalance also lies in the development of market economic system and industrial structure. In the eastern region, market institutions are gradually keeping up with the pace of institutional building further quickened after China's accession to the WTO, while in the middle and western regions, insufficient opening up to the outside and thus resulted in slow adjustment of ownership and industrial structure. In terms of sectoral development a new round of duplicated constructions resurfaced, which were mainly reflected in the following aspects: first, large projects were still launched in the traditional industries with obvious excess capacity. According to the NBS statistics on projects involving over RMB5 million yuan during January-August made by the NBS, steel projects in construction increased by 70 percent with the completed investment increasing by 1.4 times. Cement projects in construction grew by 46 percent with the completed investment growing by 1.3 times. Aluminum quarrying and metallurgy projects in construction increased by 38 percent with the completed investment increasing by 1.5 times. Automobile projects in construction increased by 75 percent with the completed investment increasing by 84 percent. Real estate projects in construction increased by 1 time with the completed investment increasing by 1.4 times; Second, so-called new and high-tech projects featured electronic information, soft ware development, new materials and biological and pharmaceutical development mushroomed; Third, a great deal of development parks of various sizes were turned into desolated. Restate price went excessively high in some cities with the development structure becoming increasingly irrational. The Third Plenum of the 16th CPC central committee explicitly called for comprehensive, coordinated and sustainable development of the economy, society and human beings. In the future, such a development philosophy shall be fully observed so as to establish an economic development system that is conducive to gradually changing the dual economic structure in urban and rural areas, to promoting coordinated economic development of different regions, to establishing a unified, liberalized modern market system featured orderly competition, to improving macro-economic management system, administrative management system and legal system, to enhancing employment, income distribution and social security system  and to advancing sustainable economic and social development.

Part Five   Projections and Outlook

I.  Projections for world economic and financial development in 2003

The overall global economic performance in 2003 is expected to be better than that in 2002. According to the latest forecast released in September by the IMF, the world economy will grow by 3.2 percent in 2003, an increase of 0.2 percentage points over 2002. The economies of the Unite States and Japan will expand by 2.6 percent and 2.0 percent, up 0.2 and 1.8 percentage points respectively over the previous year. Growth in the euro area will fall by 0.4 percentage points to 0.5 percent. Growth of developing countries as a whole is projected to increase by 0.4 percentage points to 5.0 percent. Global growth is expected to rise further to 4.1 percent in 2004, with the economies of the Unite States, Japan and the euro area expanding by 3.9 percent, 1.4 percent and 1.9 percent respectively.

World trade growth is expected to pick up gradually. Due to the major conflict of interests between industrial and developing countries on major issues ranging from agriculture to financial services in Doha multilateral trade negotiation, no agreements were reached at WTO's meeting in Cancun, and trade protectionism in major industrial countries has significantly strengthened, adversely affecting world trade development. The IMF has projected that world trade of goods and services will grow by 2.9 percent in 2003, 0.3 percentage points lower than that of 2002. As global economic outlook improves, world trade growth in 2004 is expected to accelerate to 5.5 percent.

The general trend of the development of the international financial market remains unclear. Following a strong rebound and improved stability in the third quarter, the equity markets in major industrial countries are expected to strengthen further, but vulnerability remains. Global equity market development will continue to depend largely on the strength of world economic recovery. Foreign exchange market will remain volatile, and the US dollar will generally remain weak.

Given the emerging signs of recovery in the world economy, major industrial countries are likely to maintain their current monetary policies. With subdued deflationary pressure in the Unite States, it is very likely that the Fed will keep the Federal Fund Rate at 1 percent in the remainder of the year. The European Central Bank is unlikely to further lower the refinancing rate. Nevertheless, its actions will critically depend on the economic development in the euro area. Should growth remain stagnant or further deteriorate, the European Central Bank is more likely to lower the interest rates before the end of the year. The Bank of Japan is expected to maintain its current accommodative monetary policy. With much better economic situation and much stronger inflationary pressures in the United Kingdom compared with countries in the euro area, it is highly possible that the Bank of England will be the first among the western central banks to increase interest rate.

Given the improved global political situation and reduced uncertainties, there have been signs of recovery in the world economy. The external environment of China's economic development has further improved. China's foreign trade will continue to be characterized by large volume of both exports and imports, and foreign direct investment in China is expected to maintain rapid growth. However, further depreciation of the US dollar will increase the revaluation pressure of the Renminbi. In addition, after the Fed repeatedly lowered the dollar benchmark interest rate, the interest rates of RMB deposits and loans have been persistently higher than the dollar interest rates, resulting in arbitrage opportunities between the RMB and the dollar. Therefore, foreign exchange sold to the banks may significantly increase despite narrowing trade surplus. This phenomenon deserves attention.   

II.        Projections and outlook for domestic economic and financial development in 2003

At present, macroeconomic management in China stands at a critical moment. The dynamics of self-driven economic growth has significantly strengthened. The economy has maintained a high growth rate, with prices picking up moderately and the performance of the enterprises improved. The proactive fiscal policy and sound monetary policy implemented over the past six years have continued to achieve expected results. The Third Plenary Session of the Sixteenth CPC Central Committee clearly pointed out the way forward for the socialist market economy, providing fresh impetus to the sustainable economic development. Growth in 2003 is expected to be higher than that in 2002. GDP is projected to grow by 8.5 percent. CPI will increase by about 1 percent. The growth of broad money (M2) is expected to be around 20 percent. Total lending by the financial institutions will increase by about RMB 3 trillion yuan. In 2004, the economy will continue to follow the trend observed in 2003. Preliminary forecasts show that the growth of GDP will be above 7 percent and CPI will increase by about 1 percent.

In the coming months, sustained efforts will be made to maintain the hard-achieved sound performance of the economy. The internal dynamics and growth momentum of the economy will be well strengthened, maintained and guided. Meanwhile, high attention will be given to address the deep-rooted structural imbalances and potential problems in the economy. Clear judgment is needed and a comprehensive, coordinated and sustainable development approach will be adopted.

In performing its functions of promoting sustained economic growth and maintaining the stability of the RMB and the financial system, the PBC as the central bank must strengthen its forward-looking and scientific approach to monetary policy formulation and financial macro-regulation. The PBC will continue to pursue sound monetary policy, improve indirect management tools, allow economic factors to play a major role, strengthen the coordination of various macroeconomic policies, and further improve the effectiveness of comprehensive macroeconomic management.

1.        Various means will be employed in a flexible way to ensure the continued steady growth of money and credit  

The PBC will closely monitor domestic and external economic and financial development, maintain the current monetary policy stance and promote the steady growth of money and credit. Efforts will be made to ensure that the growth of money and credit are sufficient to support economic growth. At the same time, attention will also be given to prevent banks from extending too much credit to avoid duplicated investment and systematic risks. The banks will be urged to enhance liquidity management, steadily move forward with relevant reforms, improve internal control system and establish modern financial corporate structure.

2.        Open market operations will be further strengthened to absorb excess liquidity in the market    

 

At present, foreign exchange purchases remain the major factor that contributes to the increase of liquidity in the financial system. The PBC will closely monitor balance of payments development and maintain necessary sterilization operations to absorb excess liquidity in the market. Studies on further sterilization measures will be conducted, with the aim of keeping the growth of base money at an appropriate level and preventing the unduly rapid expansion of credit.

3.        RMB interest rate will continue to be kept basically stable

In light of the current economic conditions at home and abroad, the benchmark interest rates of RMB deposits and loans will be kept basically stable. Market-based interest rate reform will be steadily advanced, and the mechanism for determining the interest rates based on market supply and demand will be gradually established and improved. While exercising sufficient degree of regulation and control, the PBC should strengthen its coordination with relevant departments and institutions. Various monetary policy instruments need to be employed to maintain stable interest rates in the money market.

4.        RMB exchange rate will be maintained basically stable and the mechanism for determining the RMB exchange rate will be further improved

China adopts a unified and managed floating exchange rate based on market supply and demand. Such a system is desirable in light of China's current economic development stage, financial regulation capacity and the ability of the enterprises to absorb shocks. Maintaining a basically stable RMB under such a system not only helps ensure the normal operation of the domestic economy, but also contributes to the sound economic development of the Asia-Pacific region and the entire world. China will keep the RMB exchange rate basically stable at an adaptive and equilibrium level. As financial reforms deepen, the mechanism for determining the RMB exchange rate will be further studied and improved to promote balance of payments equilibrium.

5.        The development of money market will be accelerated, and its financing role be enhanced

Major efforts will be devoted to promote the development of money market, since money market is important for the central bank to conduct monetary policy. The innovation of money market instruments will be actively promoted, and considerations will be given to the introduction of money market funds that are freely tradable over bank counters by enterprises and households. Market-based interest rate reform of the corporate bonds will be steadily advanced. Measures will also be taken to develop the products that can be used to hedge interest rate risk. More opportunities will be provided to individuals to manage their financial wealth. More types of bonds will be allowed for trading, and bond market liquidity will be improved.

6.        Continued efforts will be made to support the development of capital market to increase direct financing

Most enterprises in China lack capital and unduly rely on bank loans. In the past two years, the proportion of direct financing (excluding government bonds issuance) has been continuously decreasing. This presents an obstacle to the achievement of healthy capital structure of the enterprises and the prevention of systematic financial risks. Therefore, steps will be taken to support the reform, deregulation and steady development of the capital market to increase direct financing. A multi-level capital market system will be established with improved market structure and diversified market products. The development of bond market will be actively promoted.

7.        "Window Guidance" will continue to be applied as appropriate, and the financial institutions will be urged to guard against credit risk 

Measures will be taken to make "Window Guidance" better targeted. Timely risk warning will be given to banks that have significantly insufficient capital, high loan-to-deposit ratio, low reserve ratio or unhealthy asset-liability structure, and policy responses will be taken accordingly. These measures will help ensure that the banks pay attention to credit quality and slow down the growth of loans, so that credit and liquidity risks can be duly prevented.