3. China's Role in the Global Financial Crisis of 1997-1999

An important cause of the G7/8's shift to view China as an associate and potential partner was the role China played in the response to the global financial crisis of 1997-9 and in the subsequent task of reforming the international financial system. Throughout the Asian and global financial crisis of 1997-9, China approached the challenge of both crisis response and system reform with clear, consistent and quite distinctive positions. These positions often accorded with those of its Asian neighbours and placed it at odds with the emphasis of the G7. Yet from an early stage, China's positions were shared by some G7 members, including those from beyond Asia. As the crisis progressed, adjustments in the initial G7 consensus, in response to a changing reality, narrowed the still substantial policy gap. By the end, there was sufficient convergence and partial overlap that a closer and potentially fruitful dialogue between the G7 and China could be realistically envisaged.

As the Asian financial crisis opened, China faced the global economy from a position of relative strength. Unlike Japan and South Korea at a comparable stage of their economic development, China had an outward looking policy grounded in considerable amount of inward and outward foreign direct investment. Unlike Russia during the past decade, China began in a state, not of economic collapse, but of economic strain at worst, accompanied by some considerable economic strengths. The latter included a major trade surplus both overall and with the United States in particular, and the world's second largest source (after Japan) of convertible foreign exchange reserves. It was thus understandable that China was seeking to play a larger role in regional and global affairs, and that the crisis offered it an opportunity to do so.

 

a. Crisis Response

From the start of the crisis, China was active in the mobilization of resources, beyond those of the IMF from its regular mechanisms, to deploy in support packages for the beleagured Asian economies. It participated in the support package for Thailand, and in the plan for Indonesia.

China's main contribution came, as the G7 at Birmingham recognized, in not devaluing its currency and thus keep pace with and retain its competitive position vis a vis its many Asian neighbours who were devaluing theirs. It was not self-evident, at least in retrospect, that the threat of a Chinese devaluation was particularly strong. Apart from Hong Kong, the crisis placed little strain on the Chinese economy. Nor was it in China's interest to devalue. There was little pressure on their export account, which continued its large surplus, due to the relatively rising currency and soaring demand from the US, and the willingness of the latter to serve as a "spender of last resort." There was a general recognition that China's currency was locked to the US dollar, and that any devaluation could have led to a massive loss of confidence in, and flight of capital from, China itself. Closer to home, China's export markets, beginning with Japan, were afflicted by a lack of domestic demand in those economies, rather than any currency-related price elasticity relating to the goods China wished to sell. Indeed, on a trade-weighted basis, its currency suffered no net appreciation of any harmful proportion. Moreover capital inflows to China continued at a solid, if declining rate, and certainly at one well in excess of that enjoyed by its crisis afflicted Asian neighbours. Any fear of devaluation thus did not reflect the trade and debt structure of the Chinese economy.

Throughout the crisis, China proclaimed at every opportunity that it did not devalue its currency. Their Finance minister, Vice-Minister and Central Bank Governor constantly argued at IMF annual, Interim Committee, Development Committee and G24 meetings that China's refusal to devalue was its way of giving a guarantee to the international community and of maintaining stability in the region. Their emphasis on this argument may have been enhanced by their sensitivity to those private sector analysts who suggested, when the crisis broke, that its real origins lay in China's 1995-6 devaluation, and the attendant message that China favoured external adjustment rather than domestic reform of its own state-owned enterprises.

A second clear and consistent Chinese position was its very early and very strong advocacy of substantial, low-conditionality funding packages for the afflicted Asian economies. China argued vehemently that the support package to Thailand should be larger, offered earlier, with more front-end loaded disbursement, and with lower conditionality (including none regarding banking reform, corruption) than the IMF chose. It was a position that, in retrospect, appeared to some in the G7 to have had considerable merit.

On the Indonesian package China from the outset vocally opposed the rigidity of the IMF program, arguing that it went too far with fiscal compression. China's early advocacy of fiscal flexibility placed it in alliance with Japan, which was the leader in this coalition, and with Canada, which began to argue the case for stimulus and social sensitivity at an early stage. The Japanese push, aided by Canada and China, succeeded in changing IMF policy in this regard.

In these and subsequent cases the Chinese rarely departed from a narrow conception of the IMF's role. They wished to allow national authorities in afflicted Asian economies to determine what was best for their own economies. In their view, the IMF should just prepare analysis, offer options, describe costs and benefits and let the afflicted country decide what to do, rather than prescribe a particular path.

China's sense of solidarity with its Asian neighbours was further demonstrated in its willingness to contribute to the support packages, and its restraint in criticizing other Asian partners. Consistent with its belief in the "Asian way", and perhaps its fear of reciprocal criticism, its views were highly nuanced, balanced, and extremely sensitive in regard to political advice. They were a major proponent of the "Asian way", highlighting the particular circumstances and uniqueness of the East Asian societies, and thus the social and political and cultural context of any adjustment program.

 

b. System Reconstruction

China's strong supportive role in regional crisis response was accompanied by a clear approach to some of the major issues of international financial system reform. In the first instance, China argued internationally for regional responsiveness and responsibility in response to the crisis, rather than a reliance on the multilateral mechanisms of the IMF. Secondly, it was attracted, if not vocally, to the Japanese pioneered concept of a new Asian Monetary Fund, pioneered by the Japanese in the summer and autumn of 1997, as a substitute for the International Monetary Fund. Thirdly, China was very strongly opposed to letting hedge funds have the freedom to move capital in and out of countries in ways that could destroy small economies. This was a position that received the strong support of most of its neighbours in the region. And fourthly, in contrast to the new orthodoxy in favour of flexible exchange rates as a shock absorber, it tended to favour for an international regime the fixed exchange rates backed by currency intervention that it enjoyed at home.

China's approach began with a sense of Asian solidarity. It played a very active role in the debate over the Japanese proposal for an Asian Monetary Fund (AMF), initially offered as a stand-alone facility. Here China favoured a middle way, calling for complementary parallel instruments and mechanisms more sensitive to Asian values. Hong Kong was one of the earliest economies to provide the inter-bank swap arrangements among central banks that were the precursor to any AMF. Indeed, a major portion of the resources made available by other emerging Asian economies was through such provision of liquidity to central banks, with the Hong Kong contribution totaling several billion dollars.

China's support for a greater regional role was seen from the start of the crisis, in its support for the "Manila Framework" - the other strand of the now emerging Asian financial network. The Framework was designed to bring together Asian finance ministers and central bankers. Here the Japanese proposed a formal mechanism, while the ASEAN countries preferred a less formal approach. China again sought a middle way, calling for a greater degree of co-operation and a Framework that spelled out what Asian values were.

A similar positioning appeared in regard to the Asian Development Bank (ADB) - another large area where Asians countries were attempting greater regional co-operation. In the second version of the AMF, the Japanese proposed that the ADB could serve as the secretariat for the new entity. The US, Europeans and Canadians continued to resist (as they had the initial AMF proposal of a stand alone facility). China supported developing regional co-operation but never voiced support for a separate institution, or declared that they wanted to undermine the IMF and World Bank.

On the broader issues of the new architecture, China has often taken a multi-track approach, in recognition of its responsibilities for the very different societies of both Hong Kong and mainland China. This duality is evident in China's position on transparency in regard to the financial sector, corporate governance, accounting, and banking standards.

Yet there are several areas where China stands in less restrained opposition to the position of the G7. On the codes of conduct proposed by the British, Canadians and German and to some extent the US, China has been cautious. It is the most conservative country regarding the transparency of markets, the public sector, and central banks. Here it is one of the most virulent opponents, arguing that such transparency would cause not stability but greater volatility. On this issue their divergence with the G7 has widened, as Japan's initial 1997 support for discretion and confidentiality has now been replaced by a strong emphasis on publication.

China has also opposed the G7 on Codes of Good Practice for Social Policy, a project pioneered by the Britain, Canada and the US, along with Australia, which the World Bank has started working on. China has been the country most strongly opposed. While Japan has reservations about the project, it has been prepared to support it.

A further area of divergence is fiscal transparency and Codes of Good Practice on Fiscal Policy, a favorite of Canada and Britain where the IMF is currently developing a code. Here China has stood in consistent opposition. In late 1997 and early 1998 it questioned the validity and value of the whole exercise. It now stresses the voluntary nature of the code.

Despite these divergences there are several areas where China is closer to the G7 consensus. China favours lending into arrears, as do most G7 members. China, along with most G7 members, does not see moral hazard as the major problem that Germany does.

China has also been very constructive regarding hedge funds, a subject of particular PRC passion. It is very vocally concerned about how at the margins highly leveraged banking, insurance and securities firms and hedge funds can very quickly destabilize countries that are otherwise doing well. It thus calls for greater international financial regulation. Here China has been joined by Japan, Malaysia and other Asian countries, while the US, Britain, Canada and Europe remain much less concerned.

China's views here reflect a broader, longstanding analysis of the causes and impact of the Asian crisis. Along with some Asian countries it sees the virulence of the Asian crisis arising due to the behaviour of foreign institutions and how they leveraged their portfolios by pouring billions into emerging markets and then pulling these funds out at the first sign of trouble. They regard such herd behaviour, as in Indonesia, as socially destabilizing, causing massive poverty, unemployment, civil unrest, domestic strife, family breakdown and independence movements. Such results defy their desired "social market economy," a concept which gives equal weight to economic development and social stability. They thus judge IMF programs primarily according to their impact on social stability, and resist IMF involvement in issues of corporate governance, securities commissions, risk management in financial markets, social practices and political problems such as corruption.

Despite their still deeply grounded and substantially divergent positions, China has played an increasingly vocal, active, engaged, and influential role in crisis response and system reconstruction. In the great debate between Japanese and Malaysian led Asian regionalism and Bretton Woods based multilateralism, China has often taken a middle position in their public statements. On important issues, they have shared a similar position to that of Japan, Canada, and many other G7 members. Moreover, they have come to see themselves as a large country and economy, a linchpin of Asia economically along with Japan, and as a responsible international citizen. They thus wish, and feel they ought to be involved, in all relevant forums.