Massive fiscal stimulus for China

The package will be implemented via 10 areas, with investments targeted at infrastructure, social welfare and other key sectors as part of an "active" fiscal policy response as G-3 economies slide into recession, with the extent and depth of the global recession remaining unclear.

At the same time, China's central bank, the People's Bank of China, also officially shifted to a "moderately easy" monetary policy stance, which came after a series of unexpected interest rate cuts since early September and reversed the official tight policy stance announced at the end of last year.

This fiscal expansion plan is truly massive in scale and sets the benchmark for others to follow, UOB said in a research note yesterday. Even assuming that half of the 4 trillion yuan is spent next year and half in the following year, that alone accounts for about 8.9 per cent of China's nominal gross domestic product (GDP) last year of about $3.3 trillion.

The stimulus package is about 18 per cent of China's GDP last year. In contrast, China's stimulus measure in 1998 during the Asian financial crisis was about 1.2 per cent of GDP.

Last week's announcements from Japan, South Korea and Malaysia were small in comparison. For example, Japan's fiscal package of $270 billion is about 6.3 per cent of its GDP and South Korea's plan was even smaller at $11 billion or 1.1 per cent of its GDP.

More concrete announcements on how the fiscal initiatives will be spent are expected in the following months, with the first opportunity being the Central Economic Work Conference later this month.

While these measures are likely to improve investor sentiment at least temporarily, based on the size of the plan and the likelihood that other governments will follow up with a similar policy response, it is unlikely to be able to fully arrest the global recession, which is already underway as G-3 economies head into a downturn. This is because China's economy is only about $3.3 trillion in size, compared to the G-3 economies' combined size of $35 trillion, or nearly 11 times China's economy.

However, the latest development is a positive step to shore up China's own domestic demand, and UOB believes China's downside risk to growth has been reduced significantly, which helps support UOB's call of about 8.3-per-cent real GDP growth for China next year.

On the monetary-policy front, UOB expects five more interest-rate cuts from the People's Bank of China before mid-2009 to lend support to the fiscal policy initiatives. The benchmark one-year yuan lending rate should fall to 6.39 per cent this year, 5.85 per cent at end of next year's first quarter and 5.31 per cent at the end of the second quarter, from 6.66 per cent now.

The yuan should continue firming against the US dollar but only moderately, so as to balance the impact on trade and capital flows. UOB is forecasting a moderate upside to the yuan at 6.70 to the greenback this year, 6.63 by the end of next year's first quarter and 6.50 by the end of next year, versus the current spot price of 6.82.

Compiled from a UOB Economic-Treasury Research report.