BEA471 | Macroeconomics | Analysis of Macroeconomic Variables

Analysis and Discussion of Macroeconomic Variables

Real interest rate

Rate of interest in real term refers to the interest rate that is adjusted for inflation. With continuous change in price level or inflation, the value of currency in regards to its purchasing power changes. A hike in rate of inflation causes a decline in purchasing power and vice versa. Increase in inflation usually benefits the borrowers, as they have to repay a relatively smaller value of money. Reverse is the position of lenders. They lose in times of inflation as they receive a smaller return for the money lent to others (Chortareas, Kapetanios & Magkonis 2018, p. 1182). This is the reason why inflation rate needs to be considered while estimating the actual return on investment. Return on a certain sum of money might be same while estimated using nominal interest rate but it is different in real terms depending on inflation rate in two different period. Real interest rate therefore provides a closer measure of interest rate.

Figure 1: Real interest rate trend in China

(Source: The World Bank 2018)

Real interest rate trend of China is found to be consistent to that of the trend inflation rate. Years with high inflation rate indicate a lower real return. Deflationary years on the other hand have a relatively higher return. Real interest rate in china reached to the peak rate (above 5 percent) in the year 2009. The high interest rate corresponds to a very low level of inflation. As inflation began to regain, interest rate started to fall. Since 2014, there is a continuous declining trend in the interest rate. China’s government initiates a downward revision in the interest rate to stimulate economic growth. The relatively lower borrowing cost allows companies to borrow and invest in productive activity that support economic growth (Baker, Bloom & Davis 2016, p. 1610).  The slow growth of China in recent years pulls the price level to a considerably low level. With the objective of reviving economic growth, government often considered a reduction in interest rate to increase investment. The lower interest rate makes China an attractive destination of business firms. China can thus be attractive place for apparel industry of Australia.

Figure 2: Investment trend in textile and apparel industry

(Source: Textile Today 2018)

The declining real interest rate helps to increase investment in textile and apparel industry of China. In the past seven years, the industry experienced steady increases in investment.  Even during the period of declining export, the industry still maintained a steady investment growth.  Investment growth increased to 15 percent in 2015 from 13.4 percent in the previous year. The investment growth helps to expand domestic apparel industry and hence, provides Australian investors an already developed apparel market.

Government expenditures in the economy

Government spending in a country constitutes an important part of Gross Domestic Product. GDP of a nation is positively influenced by government expenditure. Government spending include investment spending, consumption and transfer payment conducted by government ((Martins & Veiga 2014, p. 580). Government finances the expenditures out of government revenue collected from tax.

Figure 3: Government expenditure in China

(Source: The World Bank 2018)

The above figure summarizes trend in government expenditure. Government expenditure is presented as a percentage of Gross Domestic Product. There is a sharp decline in government expenditure until 2010. Since 2010, government expenditure slowly increases but not as much as that in the beginning of 2000.

Domestic Credit to private sector

The private sector’s growth in an economy depends on given financial assistance by the financial institutions in the economy. The financial supports are given in the form of loan, trade credits, purchase of security and other. Availability of domestic credit plays an important role in business expansion. Supply of credit is particularly important before for setting up a new business. The flow of capital help companies to carry out capital expenditure, purchase raw materials and other expenditures (Egert, Backe & Zumer 2016, p. 115). It is favorable for businesses to enter in a nation where loans are easily available to business.

Figure 4: Availability of domestic credit to private sector

(Source: The World Bank 2018)

Followed by the above graph, there is an increasing trend in the availability of domestic credit. Domestic credit reached to the lowest level in the year 2008. This is due to the hit of global financial crisis during this period. Growing share of credit to private sector is an indicator of economic growth. Larger the share of domestic credit available from banks and different other financial institution offer a greater opportunity for expansion of private sector. The ratio of credit availability to private sector to GDP in 2013 was 133.7. In China, there is broader scope for private sectors in China as supported by the easy availability of credit. Private sector growth in China is one factor that contributes to economic growth of China. 

Credit ratio in China shows an upward rising trend indicating a positive sign for economic prosperity. During 2009–2010, the economy experienced a credit boom. The financial liberalization along with credit growth make China an attractive place for business environment. Companies have to undertake large capital investment to sustain in the market.

High capital investment has a strong positive influence on apparel industry. Availability of capital in China thus has a beneficial effect on apparel industry. China thus can be a lucrative place for investment or new business set up for apparel industry.

Taxation policy in China

In addition to government expenditure, another instrument through which government can influence economic growth is tax. The tax structure for individual is different from the designed tax structure for business. Government adjusts the tax rate depending on condition of the economy. During recession, in order to boost aggregate demand, government reduces the tax rate. Business expansion in a nation depends on the structure of tax within the nation (Martins & Veiga 2014, p. 585). Higher corporate tax rate reduces profitability of a business. Companies then prefer to relocate to other nation having a relatively less rigid structure of taxation.  Government often provides special tax concession to support business expansion.

Figure 5: Tax revenue as a percentage of GDP

(Source: The World Bank 2018)

The figure above provides shows trend in government tax revenue expressed in percentage terms of GDP. Tax revenues sharply rose during 2005 -2009. The rising revenue reflects a strong fiscal position for government. After 2009, the percentage share of tax revenue as a percentage of GDP began to fall. Decline in the tax revenue indicating stimulatory fiscal policy.

In China, there are two responsible government bodies for tax collection – one at central level and one at local level. State Administration of Tax (SAT) is the highest tax authority of the nation. Various taxes collected by the authority include corporate income tax; value added tax, tax on consumption and some other specific taxes. Under the state administration authority, the responsible authorities include local and bureau offices that collect income and other form of taxes.

Before starting business in China, the business owners must be registered at both State and local and custom bureau offices. The primary taxes that business need to pay are tax on corporate income, profit tax, tax on the derived income for doing business in China, withholding tax and VAT. Nations often alter tax rates in favor of foreign companies to attract foreign investors. China considered a tax revision favoring foreign companies in 2012 (Trade Commissioner Service 2018). The policy aimed to increase profit margin of these companies. China in order to protect domestic investors eliminated some of the benefits given to the foreign companies in 2015.

Government expenditure on infrastructure

An important determinant of foreign direct investment is infrastructure of the nation. In China, government expenditure in China in different means of transportation and other infrastructural projects increases overtime. It is responsibility of the government to invest to improve infrastructure of a nation. Government investment in transportation, communication, water, electricity and other necessary service required for development of the country. Good infrastructure helps to bring more foreign investment in the nation.

Figure 6: China’s government expenditure on infrastructure

(Source: The World Bank 2018)

The rising trend in government expenditure in China indicates concerns of the government to improve economic growth of China. The supporting role of the government helps to boost confidence of the investors and create a business friendly environment.

Exchange rate regime and exchange rate fluctuations

Exchange rate is a measure of relative price of currency between two nations. Trade and investment relations are greatly influenced by exchange rate. Nominal exchange rate refers to the unit of one country’s currency as against unit of foreign currency. Because of multilateral trade relation real effective exchange rate gives a closer measure of relative measure of domestic currency (Aghion et al. 2015, p. 25). The real effective exchange rate implies weighted averages of currency value of a nation relative to a selected index or basket containing currencies of major trading partners. The reactive currency price is adjusted for price effect. In determining weighted average value of the currency, the weights are determined from the status of trade balance between the targeted country and its trading partners. The figure below presents trend in real effective exchange rate of China.

Figure 7: Real effective exchange rate for China

(Source: The BIS, 2018)

The graph above shows that there is overtime increase in real effective exchange rate of China expressed in terms of US dollar. The real effective exchange rate actually represents price that importing nations pays to purchase goods from the overseas market. This indicates relative strength of the domestic currency. An overtime increasing trend indicates means price paid by China to overseas market increases (Comunale 2017, p. 362). This reflects a weak position of currency in the world market. Weak currency in beneficial for investors to set up business in China as it costs relatively less to start up productive operation in the country. The apparel industry thus can investment in China or set up new factories following a relatively lower value of currency.

The textile and clothing industry of China passed through several changes. One such major change is a decline in export. Despite a decline in export, apparel industry in China still remained unbeatable in the global market. The production in apparel industry has continued to expand with depreciation and increase in price of cotton. Following reform in Renminbi exchange rate in 2015, domestic currency devalued by 11. The depreciation is expected to increase export income boosting competitiveness of apparel manufacturers in China.

Figure 8: Total value of China’s export of apparel in the world

(Source: Textile Focus 2018)

Monetary policy in China

In addition to fiscal policy, another instrument used by China’s government to stabilize economic activity is monetary policy. Monetary policy aims to stabilize price level within the nation. During inflation, government attempts to reduce money supply by taking adapting tight monetary policy. Expansionary monetary policy is undertaken in times when inflation rate is below the targeted level. The expansionary monetary policy aims to increase the available money supply.

Target of monetary policy in China is to stabilize Renminbi and promote economic growth of the nation. People’s Bank of China designs monetary policy and accomplishes goals of monetary policy. Aim of the monetary policy is not only restricted price stability but it also targets to expands employment opportunity in the nation (Gay 2016, p.119). The central Bank of China intervenes in the differential of interest rate in urban and rural region.

The monetary authority in China designs the monetary policy depending on existing condition of the market. People Bank of China has recently strengthened its control in the economy and initiated financial reform to prevent financial risk. Central bank has promised to continue the prudent macroeconomic policy. Goal of the monetary policy is to maintain a considerable growth in credit along with maintaining growth in social financing (South China Morning Post 2018). Central bank in recent years has maintained its neutral and prudent monetary policy in order to keep state of liquidity at a reasonably stable.

Effects of the Global Financial Crisis (GFC) on China

The Global Financial Crisis invented in the United State during the period of 2007 – 2008. US being one of the largest economy in the world the effect of crisis spread to other nations as well. Source of the crisis was bursting of housing bubble during that started to form from the beginning of 2007 (Chen et al. 2016, p. 70). Countries that are involved in trade and investment relation in United State suffer from the attack of the crisis. Countries react to the crisis depending on the resilient nature of the respective economy.

The impact of global financial crisis in China was relatively less on China. During the crisis hit the economy experienced only a slight slow-down in economic growth. China has a relatively closed financial system. This has protected the economy from financial collapse during the recessionary phase. The economy got hurt from the reduced demand of export from the overseas market.  A relatively strong fiscal support and huge foreign exchange reserve allowed the nation to undertake internal and external borrowing without bothering for deficit (Mensi et al. 2016, p. 270). The less openness to international capital made the nation relatively less vulnerable to the worldwide recession.

Conclusion and Recommendation

The discussion so far has made, there is an overall favorable environment for business expansion in China. The macroeconomic environment of China favors spread of business. In the last few years, there is a considerable improvement in rank of China as a desirable business location. The trend in the real interest rate has a comparatively fluctuating trend. This is followed by the fluctuation in the inflation rate. Since 2014, there is a declining trend in real interest rate which is a good news for business investors. The fiscal position of China’s government is relatively strong and stable. Government makes the needed expenditure to improve economic structure and foster economic development. Another aspect that works in favor of business investment in China is the steadily increasing level of domestic credit to private enterprises. Taxation policy is China is well defined. Taxes are implemented both at state and local level that businesses and individual needs to comply. Week domestic currency, prudent monetary policy and relatively resilient nature evidenced during global financial crisis make China an attractive business destination.

China’s market thus can be a suitable place for expansion of apparel industry. In addition to the knowledge of macroeconomic environment, business forms should be well informed regarding regulatory barriers in doing business in China. The surplus labor in China is helpful for setting up factories and carrying out production. Low interest rate and weak currency might also contribute to business expansion. It is therefore recommended for apparel industry to expand its business operation in China. 

References

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Chortareas, G, Kapetanios, G & Magkonis, G 2018, Resuscitating real interest rate parity: new evidence from panels. The European Journal of Finance, 24(14), pp.1176-1189.

Comunale, M, 2017, Dutch disease, real effective exchange rate misalignments and their effect on GDP growth in EU. Journal of International Money and Finance, 73, pp.350-370.

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Gay, RD 2016, Effect of macroeconomic variables on stock market returns for four emerging economies: Brazil, Russia, India, and China. The International Business & Economics Research Journal, 15(3), p.119.

Martins, S & Veiga, FJ 2014, Government size, composition of public expenditure, and economic development. International tax and public finance, 21(4), pp.578-597.

Mensi, W, Hammoudeh, S, Nguyen, DK.and Kang, SH 2016, Global financial crisis and spillover effects among the US and BRICS stock markets. International Review of Economics & Finance, 42, pp.257-276

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The World Bank 2018, Domestic credit to private sector (% of GDP) | Data, viewed 13 October, 2018, <https://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS>.

The World Bank 2018, General government final consumption expenditure (% of GDP) | Data, viewed 13 October, 2018, <https://data.worldbank.org/indicator/NE.CON.GOVT.ZS>.

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The World Bank 2018, Tax revenue (% of GDP) | Data, viewed 13 October, 2018, <https://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS>.

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