China WT/TPR/S/199/Rev.1 
 Page 1 
 
 
I. ECONOMIC ENVIRONMENT 
(1) INTRODUCTION  
1. Since China's previous Trade Policy Review in 2006, continued trade liberalization has 
remained an integral part of the Government's l ong-standing structural reform strategy, which is 
aimed at establishing an outward-oriented "socialis t market economy" that can deliver sustained 
economic growth and facilitate pove rty reduction.  China's ongoing structural reforms coupled with 
unabated export growth and investme nt has resulted in real GDP growth rates in excess of 10% during 
the past four years, and 11.4% in 2007, the fastes t pace in 13 years (and considerably more than the 
Government's annual target of 8%)1.  As a result, China now ranks as the world's third largest 
economy (behind the United States and Japan), as we ll as the third largest tr ader (behind the United 
States and the European Communities).  Trade plays an important role in China's economy;  in 2006, 
its total merchandise trade (imports and exports ) was about 65% of GDP and over 13% of world 
merchandise trade.  Sustained high growth rates ha ve alleviated poverty, with the number of people 
living under the poverty line falling from 23.7 million in 2005 to 21.5 million in 20062;  furthermore, 
GDP per capita rose from US$1,490 in 2004 to US$2,017 in 2006 (Table I.1).  The unemployment 
rate in urban areas declined marginally to 4.0%  in 2007 (from 4.2% in 2005) .  The annual rate of 
inflation (growth in CPI) was 4.8% in 2007, up from 1.5% in 2006.3  China continues to be a major 
recipient of foreign direct investment (FDI) (toge ther with associated tran sfer of technology and 
know-how), most of which is channelled into manufact uring.  Outward FDI also rose sharply in 2005 
and 2006.  It would appear that China' s competitiveness has also improved markedly.4 
2. Notwithstanding China's rapid growth and improved competitiveness, its economy is 
characterized by a number of imbalances, several of which are interrelated.  First is the imbalance in 
the sources of growth in the economy, which has been driven much more by exports and investment than by consumption, with savings accounting for mo re than half of GDP.  The widening gap between 
China's gross national savings and gross domestic i nvestment is reflected in its growing current 
account surplus, which reached 11.0% in 2007 (c ompared with 9.4% in 2006).  Second, although 
average incomes have risen and the number of peop le living below the poverty line has continued to 
decline, income inequality has widened, esp ecially between urban and rural residents.
5  As a result, 
the Gini coefficient has been rising and is now approaching 0.50, one of the highest in Asia.6  Third, 
                                                      
1 Xinhua News  online information, "China sets 8% growth target for 2007".  Viewed at:  
http://news.xinhuanet.com/english/2007-03/05/content_580 2272.htm [10February 2008].  In the medium term, 
the Government aims to achieve an aver age annual growth rate of 7.5% so as to double the per capita GDP of 
2000 by 2010 (People's Daily online information.  Viewed at:  http://English.peopledaily.com.cn/200603/05/ 
print20060305_248054.html [11 February 2008]). 
2 Data provided by the Chinese authorities.  The poverty line is defined as annual income of less than 
Y 683 in 2005 and Y 693 in 2006.  (China's currency is called the Renminbi (RMB), with the currency 
denominated as Yuan.)  However, the World Bank estimated that in 2005, 9.9% of China's population lived in poverty, defined as living on less than US$1 (1993 purchasing power parity) a day. 
3 On a monthly basis, inflation hit an 11-year high of 7.1% in January 2008.  China's priority is to tame 
inflation, and keep it around 4.8% for 2008 ( Financial Times,  5 March 2008). 
4 According to the World Economic Forum's latest Global Competitiveness Index, China ranked 34th 
(out of 131 countries and economies) in 2007-08, up from 54th (out of 125 countries and economies) in 2006.  
Viewed at: http://www.weforum.org/pdf/Global_Co mpetitiveness_Reports/Reports/gcr_2007/gcr2007_ 
rankings.pdf and http://www.weforum.org/pdf/Globa l_Competitiveness_Reports/Reports/gcr_2006/gcr2006_ 
rankings.pdf [6 February 2008]. 
5 The urban to rural residents' income ratio was 2.9:1 in 2001;  this increased to 3.3:1 in 2006 (Asian 
Development Bank (2007)). 
6 The Gini coefficient, an inte rnationally accepted measure of inco me inequality, was 0.447 in 2001, 
and recent reports suggest that it is approaching 0.5 (an index of zero represents perfect equality, while WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 2 
 
 
the pace of China's growth has exacerbated environmental problems, including pollution.  For 
example, the production of electricity, which larg ely relies on coal, grew faster than GDP in the 
second quarter of 2007, apparently bringing about a surge in greenhouse gas emissions.  This situation 
is compounded by the relatively high energy-intensity of production7;  in 2005, for every Y 10,000 
(US$1,234) of GDP, China consumed 1.2 tonnes of coal  equivalent;  this amount is much higher than 
that in, for example, the United States or Japan.8  Fourth, the efficient allocation of the vast amount of 
investment within the economy has been hampered by, inter alia , an underdeveloped capital market 
and by incentives and other forms of assistance ac corded to manufacturing (rather than services or 
agriculture), where foreign-invest ed enterprises (FIEs) have been favoured over individual businesses 
and domestic private firms (i.e. domestic firms other than state-owned enterprises (SOEs) and 
collectively owned enterprises).  In addition, access  to finance can be more difficult for domestic 
private firms than for FIEs and SOEs, partly due to lack of collateral.  Fifth, investment has been 
skewed towards physical capital at the expense of  investment in human capital and research and 
development (R&D).  Sixth, although the tax-to-G DP ratio has been rising, not enough resources are 
devoted to "social infrastructure", such as education, health care, and basic pensions.  Seventh, a sharp 
increase in the ratio of aged population (not in the la bour force) relative to those that are employed is 
envisaged during the next two decades, putting pressure on pensio ns and the supply of labour. 
Table I.1 
Basic economic and social indicators, 2004-07 
    2004 2005 2006 2007 
Nominal GDP (Yuan billion)  15,987.8   18,386.8   21, 087.1   24,661.9  
Nominal GDP (US$ billion)    1,931.6     2,243.8     2,644.7   ..  
GDP per capita (Yuan)  12,336.0   14,103.0   16,084.0   ..  
GDP per capita (US$)    1,490.4     1,721.1     2,017.2   ..  
  (Annual percentage change) 
GDP by industry at 1978 indices     
Agriculture, forestry and fishing           6.3            5.2            5.0  3.7  
Industrya         11.5          11.6          12.9  13.4  
Construction           8.1          12.6          13.7   ..  
Services         10.1          10.5          10.8  11.4  
 Transport, storage and communication         14.5          11.3            8.3   ..  
 Wholesale and retail trade           6.6            7.8          10.9  16.7  
 Restaurants and hotels         12.3          12.3          13.6  19.4  
 Financial intermediation           3.7          14.1          18.5   ..  
 Real estate           5.9            8.7            9.1   ..  
 Other         12.6          11.0          10.0   ..  
Table I.1 (cont'd) 
                                                                                                                                                                     
1 indicates perfect inequality) ( China Daily  online information.  Viewed at:  http://www.chinadaily.com.cn/ 
bizchina/2006-06/29/content_629155.htm [11 February 2008]). 
7 This is true not just in the case of energy, but also other resources (such as steel, aluminium, copper, 
zinc and nickel). 
8 Asian Development Bank (2006a).  Other reports show that China has the third highest consumption 
of coal in relation to GDP (NationMaster.com online in formation, "Energy Statistics Coal Consumption (per 
$GDP) by Country".  Viewed at:  http://www.natio nmaster.com/graph/ene_coa_con_pergdp-energy-coal-
consumption-per-gdp [11 February 2008]). China WT/TPR/S/199/Rev.1 
 Page 3 
 
 
    2004 2005 2006 2007 
  (Per cent)  
Share of main sectors in GDP (%)     
Agriculture, forestry and fishing         13.4          12.5          11.7   ..  
Industrya         40.8          42.0          43.3   ..  
Construction           5.4            5.5            5.6   ..  
Services         40.4          39.9          39.3   ..  
 Transport, storage and communication           5.8            5.9            5.7   ..  
 Wholesale and retail trade           7.8            7.4            7.2   ..  
 Restaurants and hotels           2.3            2.3            2.3   ..  
 Financial intermediation           3.4            3.4            3.6   ..  
 Real estate           4.5            4.5            4.5   ..  
 Other         16.6          16.5          16.1   ..  
Share of sectors in total employmentb (%)     
Agriculture, forestry and fishing         42.7          41.0          39.9   ..  
Mining and quarrying           0.7            0.7            0.7   ..  
Manufacturing         12.1          12.7          13.8   ..  
Electricity, gas and water           0.4            0.4            0.4   ..  
Construction           5.6            5.9            6.3   ..  
Services         17.0          18.3          19.3   ..  
 Transport, storage and communication           2.9            2.9            3.0   ..  
 Wholesale and retail trade           7.0            6.3            6.7   ..  
 Hotels and catering            1.1            1.8            2.0   ..  
 Financial intermediation           0.5            0.5            0.5   ..  
 Real estate           0.2            0.3            0.4   ..  
Other 14.0       15.0       15.4   ..  
.. Not available. 
a Including mining and quarrying, manufacturing,  and production and supply of electricity. 
b Sectoral employment is received by addi ng up employment in urban public  sectors, in rural areas,  and in urban private and 
individual sectors; therefore, the sum of each item does not equal the total amount. 
Source:  National Bureau of Statistics of China (2007), Statistical Yearbook ;  UNDP (2006), Human Development Report ;  
and authorities of China.  
3. In order to redress some of these imbalances, the Government has taken a number of policy 
initiatives, which, in some instances, involve tr ade policy measures (such as taxes and reduced VAT 
rebates in respect of exports), whose effectiveness is dubious.  With a view to alleviating income 
inequality, the agricultural tax and most f ees charged to farmers have been abolished9, and a "rural 
subsistence welfare system" was introduced in 200 7 to provide a minimum living allowance for the 
rural poor10;  additionally, the minimum threshold for pa yment of personal income tax was raised in 
2006 and 2008.  Partly with a view to protecting the environment, VAT rebate rates have been 
reduced on exports of energy-intensive manufactured  goods;  protection of the environment is also a 
                                                      
9 It would appear that receipts of ot her taxes associated with agriculture, such as deed tax (on real estate 
transactions) and farmland occupation tax, have risen,  as have input prices, especially for fertilizer. 
10 To increase labour productivity and thus incomes in agriculture, better infrastructure, more 
mechanization, larger farm sizes (t o take advantage of economies of scale), and fewer agricultural workers 
through out-migration may be needed.  Financing of investment is also a problem for farmers as they do not own the land that they work on and thus tend to have very little collateral. WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 4 
 
 
key objective of the Government's Eleventh Five-year Plan.11  In order to redress sectoral imbalances, 
the State Council issued a document in March 2007 calling, inter alia,  for:  a three percentage point 
increase in the share of services in GDP betw een 2005 and 2010 with a view to reaching 50% by 
2020;  creation of a level playing field for domestic  and foreign players in certain services;  and 
provision of tax incentives for the development of services.12  At the same time, certain incentives, 
such as preferential tax rates, accorded mainly to  manufacturing firms, have been largely withdrawn 
with, for example, the unification of the enterprise income tax (Chapter III(4)(i)).13  China is also 
promoting a "knowledge economy" and production of  higher value-added goods so as to promote 
"indigenous" innovation and reduce China's depende nce on foreign technology from 60% to 30% (as 
measured by the ratio of its technology imports to its domestic R&D spendi ng plus net technology 
exports), thereby cutting its royalty payments.  Acco rding to the Ministry of Science and Technology, 
R&D spending is around 1.5% of GDP  (compared with 2.7%, 1.9% a nd 2.7% in Japan, EC-25 and the 
United States, respectively), which the Government  aims to increase to 2.5% of GDP by 2020.14  
Budgetary expenditure on health, educ ation, and social security has al so been increased.  In addition, 
the Government is in the process of reforming its pension system with a view to facilitating more 
contributions and extend ing coverage.  The extent to wh ich these measures address the various 
imbalances in the economy remains to be seen. 
(2) RECENT ECONOMIC DEVELOPMENTS  
4. Real GDP growth in China was 11.4% in 2007 (Tab le I.2).  Economic growth has been driven 
mainly by manufacturing, especially exports of manufactured goods (which grew by over 25% in 
2007) and investment (which outpaced domestic c onsumption).  Growth of value added in the 
industrial sector averaged over 13% in 2006 and 2007.15  Domestic investment was fuelled by 
reinvested profits of firms (particularly SOEs) a nd easy credit conditions, arguably reflecting excess 
liquidity in the banking system;  the share of gro ss domestic investment in GDP increased from 43.3% 
in 2005 to 44.9% in 2006.  Increased investment has helped labour productiv ity in manufacturing to 
outpace wage growth;  thus, the ratio of wages to  total value added in manufacturing has declined, 
resulting in higher profits for firms, and higher nationa l saving in relation to GDP.  More broadly, the 
share of wages in GDP declined from 53% in 1998  to 41% in 2005, while consumer spending was 
less than 36% of GDP in 2006 (compared with over 50% of GDP in India, Japan, South Korea and the 
United States).16 
                                                      
11 The Plan aims to achieve economic development that is "comprehensive, harmonious, and 
sustainable".  The main objectives under the Plan include:  doubling per capita GDP between 2000 and 2010;  
reducing energy intensity by 20% over the course of the Plan;  increasing urbanization from approximately 40% 
in 2005 to 48% by 2010;  increasing both rural and urban incomes by 5% per annum;  and substantially 
increasing health coverage and education for rural residents. 
12 Several Opinions of the State Council for Accel erating Development of the Services Industry. 
Viewed at:  http://www.fdi.gov.cn/ pub/FDI_EN/Laws/InvestmentDirection/IndustrialGuidance/P0200707125 
70808281170.pdf  [11 February 2008].  The State Council intends to create a "Leading Group for Service Sector Development", with an office in the National Development and Reform Commission (NDRC). 
13 The unification of the tax rate is also likely to eliminate the incentive for "round tripping" of 
domestic capital disguised as foreign, enabling it to take advantage of incentives offered to FIEs. 
14 China's commitment to R&D wa s emphasized in President Hu Jintao's address to the 17th National 
Congress of the Communist Party of China, where he pledged to increase spending on innovation. 
15 Asian Development Bank (2006b). 
16 The Economist,  11 October 2007, and World Bank (2006c). China WT/TPR/S/199/Rev.1 
 Page 5 
 
 
Table I.2 
Selected macroeconom ic indicators, 2004-07 
  2004 2005 2006 2007 
National accounts (%)     
Real GDP (production based) 10.1 10.4 11.1  11.4  
   Consumption 7.1  9.4  10.3  10.9 
   Gross fixed capital formation 16.8  16.8  14.9  12.9  
Unemployment ratea  4.2  4.2   4.1  4.0  
Prices and interest rates     
Inflation (CPI, %age change) 3.9 1.8 1.5 4.8  
Lending rate (period average) 5.58  5.58   6.12   ..  
Deposit rate (period average) 2.25  2.25  2.52   ..  
Money credit (end period) (%)     
Money supply (M2) 14.9 17.6 16.9 16.7  
Credit to private sector (end period) 8.1 11.7 15.1 14.1  
Exchange rate     
Yuan per US$ 8.277  8.194 7.973   ..  
Real effective exchange rate index (%age change)b -2.6  -0.2  2.1   ..  
Nominal effective exchange rate index (%age change) -4.5  0.1  2.7   ..  
Fiscal policyc (% of GDP)     
Government balance -1.3 -1.2 -0.1 -0.6  
Total revenue 16.6 17.8 18.9 19.8  
   Tax revenue 15.1 15.7 16.5  ..  
Total expenditure 18.0 19.0 19.4 20.4  
Public sector total debt 20.2  17.7  16.6   ..  
   Domestic debt  17.5  17.3  16.3   ..  
Saving and investment (% of GDP)     
Gross national savings 42.9  50.5  54.4   ..  
Gross domestic investment 39.3 43.3 44.9   ..  
Savings-investment gap 3.6 7.2  9.5   ..  
External sector (% of GDP)     
Current account balance  3.6 7.1 9.5 11.0 
Net merchandise trade  3.1 6.0 8.2 ..  
   Value of exports 30.7 34.0 36.7  ..  
   Value of imports 27.7 28.0 28.4  ..  
Services balance -0.5 -0.4 -0.3  ..  
Capital account 0.0 0.2 0.2  ..  
Financial account  5.7 2.6 0.2  ..  
   Direct investment 2.8 3.0 2.3  ..  
Balance of payments  10.7 9.2 9.3  ..  
Merchandise exports (%age change) 35.4 28.5 27.2  ..  
Merchandise imports (%age change) 35.8 17.6 19.7  ..  
Table I.2 (cont'd) WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 6 
 
 
  2004 2005 2006 2007 
Service exports (%age change) 33.6 19.2 23.6  ..  
Service imports (%age change) 30.4 16.2 20.3  ..  
Gross official reservesd (US$ billion) 614.5  821.5  1,068.5  1,530.5  
Total external debt (US$ billion; end period) 228.6  281.0  323.0   ..  
Debt service ratioe 3.2  3.1  2.1   ..  
a Registered unemployment in urban areas. 
b A positive increase in the real effective ex change rate means an appreciation of Re nminbi relative to the other major currenc ies 
in the index. 
c GFS basis;  central and local government s, including all official external borrowing.   The data are not adjusted for accumula tion 
of arrears in tax rebates to exporters during 2000-02, and the re payment of these arrears in 2004 and 2005. Such an adjustment 
would increase the deficit in 2000-02 and lower it in 2004-05. 
d Excluding gold. 
e Debt service ratio refers to the ratio of  the payment of principal and interest of foreign debts to the foreign exchange rece ipts 
 from foreign trade and non-trade services of the current year. 
Source:  National Bureau of Statistics of China (various issues), Statistical Yearbook ;  State Administration of Foreign 
Exchange online information.  Viewed at:  www.safe.gov .cn/model_safe_en/index.jsp;   International Monetary 
Fund (various issues), International Financial Statistics ;  World Bank (2008), China Quaterly Update,  February;  
and data provided by the authorities. 
5. China's high gross domestic investment rate  has expanded production capacity to meet 
growing demand.  While investment in some sector s (notably steel and aluminium) has been arguably 
excessive, the expansion of production capacity h as helped alleviate inflationary pressure.  
Nevertheless, inflation as measured by consumer pri ce index (CPI) has been rising, reaching 4.8% in 
200717, compared with a People's Bank of China (P BC) indicative target of 3% for the year.18  The 
rise in inflation is due largely to increasing food prices, especially those of grain and meat;  in 
January 2008, for example, food prices (which ma ke up a third of the CPI) rose by over 18%  
(year-on-year), whereas price in creases in non-food items were around 1%.  As the relatively poor 
spend a disproportionate amount of their incomes on food (30%-50%), higher food prices would tend 
to exacerbate inequality.19  The CPI does not capture the full extent of inflation, however, as some of 
the prices included in the index, such as those of el ectricity, coal (used for electricity generation) and 
refined petroleum, are controlled by the Government  (Chapter III(4)(iv)).  Moreover, interim export 
taxes on grain, including wheat, rice, corn, and soya b eans, are levied at rates of between 5% and 25% 
in 2008;  such taxes tend to discourage exports  and increase domestic supply and thereby dampen 
price increases.20  The Government also started to c ontrol the prices of basic foodstuff from 
January 2008 (Chapter III(4)(iii)(b)).21  In addition, interim import tariffs on some 620 tariff lines, 
including soya beans and edible fat, were reduced on 1 January 2008 (Chapter III(2)(iii)). 
6. In 2007, the urban unemployment rate fell from 4.1% (in 2006) to 4.0%, with 12.04 million 
new urban jobs being created.22  On the other hand, the Na tional Development and Reform 
Commission (NDRC) reportedly estimated that in 2006, 25 million new jobs were needed nationwide 
to absorb new additions to the labour force and to re-employ the unemployed.23 
                                                      
17 Monthly CPI was over 6% year-on-y ear between August and December 2007. 
18 World Bank (2007). 
19 BBC News.  Viewed at:  http://news.bbc.co.uk/ 2/hi/business/7180442.stm [10 January 2008] 
20 Financial Times.   Viewed at:  http://www.ft.com/cms/s/0/ffd91b16-b700-11dc-aa38-0000779fd2 
ac.html [11 February 2008]. 
21 Financial Times.  Viewed at:  http://www.ft.com/cms/s/0/a1199c74-be9c-11dc-8c61-0000779fd2ac, 
dwp_uuid=9c33700c-4c86-11da-89df-0000779e2340.html [11 February 2008]. 
22 No data on nationwide unemployment rate are available.   
23 Asian Development Bank (2007). China WT/TPR/S/199/Rev.1 
 Page 7 
 
 
7. Against the background of the Government's e ffort to promote investment in manufacturing 
through tax and non-tax measures, manufacturing in  China has grown much faster than services and 
agriculture.  Consequently, the share of industry (including manufacturing, mining, and electricity generation) in GDP (43.3%) was higher than that of  services (39.3%) and agriculture (11.7%) in 2006 
(40.3%, 39.4% and 14.8%, respectively, in 20 00).  Although the Government's emphasis on 
manufacturing may also have resulted in an ineffi cient allocation of capital in the economy, it has 
provided manufacturing workers with more capital to  work with, thus raising labour productivity and 
wages in manufacturing more than in non-manufactu ring.  For example, as about 40% of China's 
labour force is employed in agriculture, which accounts for 11.7% of GDP, labour productivity in 
agriculture is only one-fifth that in the rest of the economy.
24  As a consequence, wage differentials 
between manufacturing and non- manufacturing have widened. 
8. As regards the external sector, China' s current account surp lus increased from 
US$160.8 billion in 2005 to a bout US$361 billion in 2007, representing 7.1%  and 11.0% of GDP, 
respectively.25  The increasing surplus reflects a widening gap between gross national savings and 
gross domestic investment.  Alt hough gross domestic investment has been high (44.9% in 2006) in 
China, gross national savings have been consistently higher (54.4% in 2006).  It would appear that a 
large portion of household saving is precautionary, aimed especially at the provision of education, healthcare, and retirement income;  also, the lack  of a deep and extensive financial system has 
motivated households to save in order to enab le self-financing of fami ly-owned businesses.  
Furthermore, corporate saving remains high.
26 
9. The increase in the current account  surplus in recent years also  reflects an increase in the 
merchandise trade surplus (Table I.3).  China's exports  grew rapidly, owing mainly to a large increase 
in manufactured exports, whose share in GDP rose from 30.7% in 2004 to 36.7% in 2006 (the latest year for which data were available);  imports also  grew during the same period, albeit at a slower 
pace.  The services trade balance has been in a slight deficit. 
10. Despite large portfolio outflows in 2006, ag ainst the background of China's easing of capital 
controls by allowing certain capital outflows throug h the "qualified domestic institutional investors" 
(QDII) (section (3)(i)), the capital account remained in  surplus due to FDI inflows and other foreign 
investments.
27  Existing capital controls may have contri buted to such a surp lus.  The surpluses on 
both the current and capital accounts are reflected in China's foreign exchange reserves, which 
increased from US$819 billion in 2005 to US$1,530 b illion at end 2007, amounting to more than 
19 months of import cover;  the authorities indicate that the reserves are also equivalent to 5.8 times 
short-term external debt.28   
                                                      
24 This also gives rise to speculation about large under-employment in agriculture (World Bank 
(2007a)). 
25 IMF (2007c). 
26 In 2005, it was estimated that corporate savings accounted for 20.4% of GDP, household savings 
16.2%, and government savings 5.7% (He and Kuijs (2007)). 
27 Although FDI inflows declined slightly in 2006, th ey continue to be robust.  Investment outflows, 
both in terms of outward FDI and portfolio investment, have also shown marked increases, implying China's 
growing involvement in the world economy. 
28 Reportedly, more than 70% of China's rese rves are invested in U.S. dollar assets ( Financial Times , 
5 January 2006, "China signals reserve switch away from  dollar").  At the time of China's first Trade Policy 
Review, when the interest rate paid by the PBC on "ste rilization bonds" was higher than that received by the 
PBC on its reserves, the authorities were then making a profit on this interest rate spread.  With the recent fall in 
U.S. interest rates, however, the PBC will be receiving a bout 250 basis points less on its U.S. Treasur y bills than 
the (roughly) 4% it pays on its "sterilization bonds".  The outcome is an estimated monthly loss of about 
US$4 billion on the PBC's sterilizati on operations, with the trend accelera ting because reserves are growing 
faster than GDP ( Financial Times , 1 February 2008, "Beijing starts to pay for forex 'sterilization'"). WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 8 
 
 
Table I.3 
Balance of payments, 2004-07 
(US$ billion) 
    2004 2005 2006 2007 
(January-June) 
Current account 68.7 160.8 253.3 162.9 
Goods and services balance 49.3 124.8 208.9 132.5 
    Trade balance 59.0 134.2 217.7 135.7 
       Exports 593.4 762.5 969.7 547.2 
       Imports 534.4 628.3 751.9 411.5 
    Services balance -9.7 -9.4 -8.8 -3.1 
       Receipts 62.4 74.4 92.0 55.9 
    Transportation 12.1 15.4 21.0 13.6 
    Tourism 25.7 29.3 33.9 17.9 
    Communication 0.4 0.5 0.7 0.6 
    Construction 1.5 2.6 2.8 1.9 
    Insurance 0.4 0.5 0.5 0.5 
    Financial 0.1 0.1 0.1 0.1 
    Research and development 3.2 5.3 7.8 4.9 
    Other commercial services 16.0 16.9 19.7 13.0 
    Other 3.1 3.7 5.3 3.4 
       Payments 72.1 83.8 100.8 59.0 
    Transportation 24.5 28.4 34.4 18.4 
    Tourism 19.1 21.8 24.3 14.6 
    Communication 0.5 0.6 0.8 0.5 
    Construction 1.3 1.6 2.0 1.3 
    Insurance 6.1 7.2 8.8 4.8 
    Financial 0.1 0.2 0.9 0.3 
    Research and development 4.7 6.2 8.4 5.1 
    Other commercial services 8.5 9.4 11.3 8.1 
    Other 7.2 8.4 10.0 5.9 
Income balance -3.5 10.6 15.2 12.9 
       Credit 20.5 39.0 54.6 34.1 
       Debit 24.1 28.3 39.5 21.2 
Current transfers (net) 22.9 25.4 29.2 17.4 
       Credit 24.3 27.8 31.6 19.0 
       Debit 1.4 2.3 2.4 1.6 
Capital and fina ncial account 110.7 63.0 6.7 90.2 
Capital account -0.1 4.0 4.0 1.5 
Financial account 110.7 58.9 2.6 88.7 
   Direct investment 53.1 67.8 56.9 50.9 
      Chinese direct investment abroad -1.8 -11.4 -21.2 -7.4 
      Foreign direct investment in China 54.9 79.1 78.1 58.3 
   Portfolio investment 19.7 -4.9 -67.6 -4.8 
      Assets 6.5 -26.2 -110.4 -15.1 
      Liabilities 13.2 21.2 42.9 10.3 
   Other investment 37.9 -4.0 13.3 42.6 
      Assets 2.0 -48.9 -31.9 17.1 
      Liabilities 35.9 44.9 45.1 25.5 
Net errors and omission 27.0 -16.8 -12.9 13.1 
Reserve assets -206.4 -207.0 -247.0 -266.1 
Source:  Data provided by the Chinese authorities. China WT/TPR/S/199/Rev.1 
 Page 9 
 
 
(3) MACROECONOMIC POLICIES  
(i) Monetary policy 
11. The People's Bank of China (PBC) assumes the ro le of the central bank in accordance with a 
State Council decision (announced in September 1983) .  Under the guidance of the State Council, the 
PBC, inter alia,  "formulates and implements monetary polic y, prevents and resolves financial risks, 
and safeguards financial stability".29  The PBC is also responsible fo r "administering foreign exchange 
and regulating the inter-bank foreign exchange mark et". The objective of monetary policy is "to 
maintain the stability of the renminbi  and thereby promote economic growth".30  The PBC must 
submit to the State Council for approval its decisions  concerning annual money supply, interest rates, 
exchange rates, and other important matters before they are put into effect.31  It must also report to the 
Standing Committee of the National People's Congr ess on the conduct of monetary policy and the 
performance of the financial sector.32 
12. Since China's previous Trade Policy Review, its monetary policy has been driven largely by 
the need to mop up excess liquidity, reduce credit growth and investment, and consequently cool 
economic growth.  In addition to "sterili zation" and moral suasion ("window guidance")33, 
instruments used by the PBC during the period under review include increases in the reserve ratio of 
banks, as well as increases in deposit and lending ra tes.  The PBC raised the benchmark one-year 
lending rate by 0.27 percentage points to 5.85% in April 2006.  Subsequently the rate was raised 
seven times and stood at 7.47% in Decemb er 2007.  The "benchmark deposit rate"34, as announced by 
the PBC, has also been rising since August 2006, a nd was at 4.14% in December 2007.  In addition, 
since January 2007, the PBC has raised the required reserve ratio 11 times, with the result that the 
ratio is now 15%.35  Other steps taken by the PBC include:  issuing "penalty bonds" (which bear 
interest rates lower than the market rates) to banks that had credit growth in excess of that specified in 
the PBC's "window guidance" policy36;  and administrative measures that regulated investment in the 
capital market, real estate sector and new investment projects.37  Against this background, growth in 
money supply in terms of M2 declined slightly to 16.7% in 200738, compared with 16.9% in 2006;  
while credit growth also fell to 14.1% in 2007 (15.1% in 2006).39  However, it would appear that the 
                                                      
29 People's Bank of China online informati on.  Available at:  http://www.pbc.gov.cn. 
30 Article 3 of the Law on the People's Bank of China. 
31 Article 5 of the Law on the People's Bank of China. 
32 Article 6 of the Law on the People's Bank of China. 
33 Such "guidance", involving monthly meetings with commercial banks to urge them to avoid 
excessive credit expansion without placing a hard brake on  lending, tends to distort the capital market compared 
with the use of market-based pricing instruments, and prevents the capital market from allocating credit to the 
most profitable investments. 
34 The benchmark deposit rate is the commercial bank's one-year interest rate paid on deposits with the 
central bank. 
35 The recent increase in the amount of  reserves that commercial banks are required to deposit with the 
PBC might be partly explained by the potential losses by the PBC on its sterilization operations;  the interest rate 
paid by the PBC on these deposits is currently 1.89%, considerably less than the 4% paid on "sterilization 
bonds". 
36 "Penalty bonds" have an interest rate that is le ss than the market rate and are aimed at containing 
liquidity growth in the market, much in the same way as sterilization;  the only differen ce is that these bonds are 
not issued against foreign exchange inflows, but rather target existing M2  (World Bank (2006b)). 
37 World Bank (2006b). 
38 M2 in China is defined as currency in circulatio n, enterprises' current sa vings, enterprises' fixed 
savings, saving accounts, and other deposits. 
39 World Bank (2007b) and (2007d). WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 10 
 
 
PBC's ability to use interest rates as an effective monetary policy measure is relatively limited owing 
to China's exchange rate regime. 
13. The Chinese authorities state that they have  been implementing a "managed floating" 
exchange rate system with reference to a basket  of currencies based on market supply and demand 
since 21 July 2005.40  However, since August 2006, China's ex change rate regime has been classified 
by the IMF as a "crawling peg".41  According to the IMF, the observe d path of the exchange rate and 
reserve build up, coupled with information regarding intervention, suggest that the exchange rate was 
mainly determined by official action, prompting this classification.42  Currently, the daily exchange 
rate between the U.S. dollar and the RMB is allowe d to fluctuate within a 0.5% band of the central 
rate43, which is announced by the China Foreign Excha nge Trading Centre, a subsidiary body to the 
PBC.44  Since revaluation in July 2005, the RMB has appreciated from Y 8.28 per U.S. dollar to 
Y 7.18 per U.S. dollar in February 2008, an appreci ation of over 13%.  According to the authorities, 
the exchange rate in relation to other currencies is  also allowed to fluctuate within a band announced 
by the PBC.  The RMB depreciated by over 5% agai nst the euro, from Y 10.07 per euro in July 2005 
to Y 10.65 per euro in February 2008;  by contr ast over the same period, the RMB appreciated by 
over 10% against the Japanese yen (JPY), from Y 0.075 per JPY to Y 0.067 per JPY.  Since 
July 2005, both the real effective exchange rate (REER) and nominal effective exchange rate (NEER) 
have been appreciating, albeit not as significan tly as the appreciation against the U.S. dollar45;  the 
appreciation of the REER and NEER reflects the RM B's depreciation against other major currencies, 
i.e. the euro and pound sterling, as well as rising inflation in China.46   
14. While China has relaxed some capital market cont rols (see below), by and large, the RMB is 
not traded freely internationally.47  Part of the constraint on international trading of the RMB is that 
the domestic banking sector and capital markets are not  sufficiently developed to withstand internal 
and external financial shocks.  A more flexible exch ange rate regime could en able China to operate a 
more independent monetary policy, which would be better suited to ach ieving a low and stable rate of 
                                                      
40 On 21 July 2005, China announced a 2.1% revalua tion of the renminbi-U.S. dollar exchange rate and 
a change in its exchange rate arrangement to allow the va lue of the renminbi to fluctuate based on market supply 
and demand with reference to an undisclosed basket of curr encies.  To permit a greater role for market forces in 
determining the renminbi exchange rate, steps have been  taken since July 2005 to liberalize and develop China’s 
foreign exchange markets, including the establishment of an over-the-counter spot foreign exchange market and markets for currency swaps and futures (IMF (2007a)).  De spite the RMB's appreciation in relation to the U.S. 
dollar, China's trade surplus with the United States has c ontinued to grow.  This is not surprising as it is not 
obvious how an appreciating RMB would narrow the gap between China's national saving and gross domestic investment.  An appreciation of the exchange rate co uld increase domestic consumption insofar as it reduces 
import prices and thereby stimulates consumption of imported goods (and to the extent that imported goods are 
not pure substitutes of domestically produced goods). 
41 For the IMF's definition of a crowling peg, see IMF online information, "Classification of Exchange 
Rate Arrangements and Monetary Policy Frameworks".  Viewed at:  http://www.i mf.org/external/np/mfd/er/ 
2004/eng/0604.htm [11 February 2008].   
42 IMF (2007a). 
43 Prior to May 2007 the band was 0.3%.   
44 The central rate of RMB against the U.S. dollar is  determined based on certain "enquired" prices of 
market makers before the opening of the market each day (China Foreign Exchange Trade System and National 
Interbank Funding Center, "RMB/Foreign Currency Spot Trading", online information.  Viewed at:  http://www.chinamoney.com.cn/column/ english/a bout/services/index.html [11 February 2008]). 
45 According to the BIS, the nominal effective exch ange rate of the RMB appreciated by 3.96%, and 
the real effective exchange rate by 8.59 % between July 2005 and November 2007. 
46 IMF (2007b), data available only for June 2007. 
47 Capital controls may be circumvented to some extent by practices such as under-invoicing of imports 
(and over-invoicing of exports), which would tend to inflate the current account surplus.  Combating such practices may require more onerous customs valuation of imported (and exported) products. China WT/TPR/S/199/Rev.1 
 Page 11 
 
 
inflation in both product and asset markets and a llow market forces to assume a greater role in 
determining interest rates.48  To the extent that the authorities cannot fully sterilize capital inflows, the 
outcome may well be higher domestic inflation, wh ich would tend to push up the real effective 
exchange rate. 
15. The capital account was liberalized slightly in 2006 by allowing outward investment in fixed 
income securities for "qualified domes tic institutional investors" (QDII)49;  other liberalization 
measures announced by the PBC include raising the limit on purchases of foreign exchange by 
individuals to US$50,000 in February 2006.  However, capital account restrictions, including 
repatriation requirements remain.50  On the other hand, rules on inflows have been tightened to make 
exchange rate speculation more difficult;  the measur es taken include strengthened controls on foreign 
capital inflows into the real estate  market, and controlling the increase of short-term foreign debt by 
reducing the quota of foreign in vested financial institutions.51 
(ii) Fiscal policy 
16. Since its previous Trade Policy Review, Ch ina's fiscal position has strengthened, with 
revenue increasing faster than expenditure.  Total revenue (excluding bond issues) as a percentage of 
GDP grew from 16.6% in 2004 to 19.8% in 2007, while expenditure grew from 18% in 2004 to 
20.4% in 2007.  Consequently, the fiscal defici t fell from 1.3% of GDP in 2004 to 0.6% in 2007.52  
The sustained decrease in the fiscal deficit has led to  a decline in the level of public debt from 17.5% 
in 2005 to 16.3% of GDP in 2006.   However, the level of public debt does not capture the full extent 
of the State's indebtedness, as it does not include th e Government's contingent liabilities, such as the 
full cost of pension commitments and the potential co st of bailing out state-owned banks in the event 
of the latter making insufficient provisions for their non-performing loans (NPL).53   
17. The total tax-to-GDP ratio increased from 15% in 2004 to 16.5% in 2006.54  The growth in 
tax revenues can be attributed to fast growth of  the economy, leading to higher corporate profits, 
higher incomes, and increased consumption.55  Recent tax measures aimed at containing investment 
and credit growth, such as the imposition of a 20% capital gains tax on real estate and the stamp duty 
on stock trading, have also contributed to the growth  in tax revenues.  In 2006, real estate tax receipts 
rose 35%, while tax receipts from stamp duty on st ock market transactions almost tripled, from 
                                                      
48 While any assessment of whether a currency is undervalued (and the extent of such undervaluation) 
is fraught with analytical difficulties, the lack of flexibility  of the exchange rate and its alleged undervaluation is 
seen by some as providing an a dvantage to China's exports.   
49 The QDII scheme allows Chinese citizens to invest in overseas equities markets, with designated 
foreign currencies, through qualified institutional invest ors, such as fund management companies.  (PBC 
Announcement No. 5 of 2006.  Viewed at:  http:// www.pbc.gov.cn/english/detail.asp?col=6400&ID=668 
[11 February 2008].) 
50 See IMF (2007a) for details of Ch ina's capital accoun t restrictions. 
51 It would appear that a foreign invested financial institution needs to obtain approval for the annual 
amount of total foreign debt it can undertake (the annual "quota"). 
52 These figures pertain to central and local governments, including a ll official external borrowings.  
The data are not adjusted for accumulation of arrears in tax rebates to exporters during 2000-02 and the 
repayment of these arrears in 2004 an d 2005.  Such an adjustment would increase the deficit in 2000-02 and 
lower it in 2004-05. 
53 The fiscal figures do not take into account the potential quasi-fiscal cost of "sterilization". 
54 China would appear to be a low-tax country compared with OECD countries, whose average tax to 
GDP ratio exceeds 36%.  Some developing countries, such  as Brazil, are also approa ching the same tax to GDP 
ratio as OECD countries. 
55 During the first half of 2006, corporate profits in industry rose by 28%, nine percentage points 
greater than the same period in 2005 (World Bank (2006b)). WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 12 
 
 
Y 6.7 billion in 2005 to Y 17.9 billion in 2006.56  With a large proportion of the investment in 
manufacturing coming from reinvested earnings, especially by SOEs, the Government is considering a reform requiring SOEs' profits to be paid to the Government in the form of dividends.  These 
dividends would be used as extra-budgetary expendi ture on social services and rural development 
(thereby possibly increasing domestic consumption).  In this regard, the State Council announced in 
September 2007 that a special budget to utilize SOE profits for social expenditure and SOE reform 
would be set up in 2008.
57   
18. The Government has been increasing expenditu re on social services so as to promote a 
"harmonious society" as well as other goals set out in the Eleventh Five-year Plan.  The Government 
apparently increased expenditure on health a nd education in 2006, with the 2007 budget also 
following the same trend.58  Expenditure on education was set to exceed 3% of GDP in 2007, up from 
2.9% in 2006, with a longer term goal of reaching 4% of GDP by 2010.  The Ninth Five-year Plan for 
Educational Development aimed to abolish rural e ducation fees by 2010;  this was achieved in 2007.  
According to the authorities, the budgetary alloca tion for rural health was more than doubled, to 
Y 11.4 billion in 2007.59  As of September 2007, 729 million (o r 86% of the rural population) had 
joined the rural cooperative health care system.60  Development of rural areas, another pillar of 
China's policy objectives, is also reflected in the recent fiscal cha nges, such as the introduction in 
2006 of a "rural subsistence welfare system", wh ich established a minimum living allowance for the 
rural poor, and the abolition in 2006 of the agricultu ral tax.  Some measures aimed at improving rural 
welfare appear to have adversely affected the fiscal circumstance s of local governments.61  To the 
extent that fiscal transfers from the Central Governme nt have not been sufficient to meet shortfalls in 
local authorities' revenues compared to their e xpenditures (especially on investment and salaries), 
local governments have apparently resorted to fina ncing their deficits through, for example, sale of 
real estate.62 
19. Pensions constitute the Government's largest contingent liability, which is expected to 
increase on account of China's ageing population.  Th e present pension system covers approximately 
190 million people63;  the Government plans to extend coverage to 220 million by 2010.  The 
Government introduced a new scheme in January 2 006, involving a formula linking benefits more 
closely to contributions;  consequently, when employees contribute for more than the minimum 
prescribed period (15 years), they will receive an ex tra percentage point of basic benefits for every 
extra year of contributions.  The Government also  plans to adopt a special budget for SOEs in 2008 
making provisions for unforeseeable fu ture expenditures, in addition to the existing National Security 
Fund set up in 2000;  the latter is a pension fund th at is expected to finance future social security 
                                                      
56 Receipts from stamp duty on stock market transac tions are expected to c ontinue rising, as the 
Government increased the duty rate from 0.1% to 0.3% in May 2007. 
57 China Daily,  "Special Budget", 17 September 2007.  Vi ewed at: http://www.china.org.cn/english/ 
GS-e/224686.htm [11 February 2008]. 
58 World Bank (2007a). 
59 China spends less than 3% of its GDP on social security, and its  health budget accounts for only 
0.6%.  China's East Asian neighbours spend, on average, 10-20% of GDP on social security and 2-8% on health.  
According to the authorities, the health care budget was Y 165 billion in 2007 (Y 132 billion in 2006). 
60 World Bank (2007b). 
61 These measures include:  a Central Government restriction on the conversion of farmland into 
commercial land;  banning the construction of golf course s and luxury developments on undeveloped land;  and 
the requirement to record la nd sales as an on-budget item.  Subna tional (provincial) governments account for 
70% of China's total budgetary expenditure.  Provincial governments are responsible for, inter alia,  expenditure 
on health, social security, and education. 
62 Local governments are ostensibly required to ba lance their budgets annually and are prohibited from 
borrowing, unless approved by the State Council. 
63 The majority of people with pension provisions are in urban areas. China WT/TPR/S/199/Rev.1 
 Page 13 
 
 
expenditures.  However, problems may remain, such as the large amount of legacy debt and the 
fragmentation and decentralization of pension sch emes, which have resulted in disparities across 
provinces and municipalities, as well as, across enterprises.64  Immature capital markets, which make 
it difficult to find suitable investments with high return s (see below), also appear to be a concern for 
the National Social Security Fund.   
20. Recent reforms to improve fiscal transparency include:  the "Golden Fiscal Project" (launched 
in 2006), which aims to computerize the budgeting a nd public expenditure processes in five years;  
and a new budget classification system introduced in  2006.  According to the authorities, the new 
classification system identifies in detail all sources of government revenue (inc luding extra-budgetary 
funds).  Expenditure items are also reclassified and described in detail;  for example, defence, 
diplomacy, and education have replaced previous cat egories such as administration, construction and 
institutions.  Also, the budget committee of the National People's Congress (NPC) is formulating a new law on inter-government fiscal transfers, and is revising the Budget Law.  
(4) M
AIN STRUCTURAL REFORM ISSUES  
(i) Environmental policies 
21. While the Government's overriding policy obj ectives still appear to be strong growth and 
consequent poverty reduction, it has concerns over the deterioration of the environment, including 
pollution, which is partly the consequence of a de velopment strategy that has tended to under-price 
primary resources, especially energy, used as i nputs.  Accordingly, the authorities have taken 
measures to arrest environmental deterioration.   These include:  reducing VAT rebates on exported 
goods deemed energy-intensive and highly polluting;   and "green credit policies" that provide 
preferential credit to "environment-friendly end eavours" at the expense of energy-intensive 
industries.65  The authorities also intend to shut down small coal mines and small coal-based 
electricity producers, and to provide subsidized lo ans for desulphurization.  They are aware of the 
need to price energy inputs, such as electricity and petroleum, properly.  As a result, in 2006, energy intensity (the amount of energy required for every U.S. dollar produced in the economy) fell by 
1.33%, albeit significantly lower than the Gove rnment's 4% annual re duction target under the 
Eleventh Five-year Plan
66;  energy intensity fell by 3% in the first nine months of 2007.67  More use of 
economic instruments, such as tradeable pollution permits and increased taxes on energy resources, 
including coal (a possible form of "carbon tax"), ma y be needed to achieve the Government's targets;  
export taxes are likely to be less effective inst ruments for achieving these targets (see below).   
(ii) Tax reforms 
22. China's recent tax reforms reflect, inter alia,  the Government's desire to establish a more 
neutral internal tax system.  Major reforms include , for example, unifying the enterprise income tax 
                                                      
64 "Legacy debt" is unfunded liabilities from the old pension system un der SOEs, which ceased 
in 1997. 
65 China's new green credit policy requires corporate offenders to be reported to the PBC, which 
penalizes these firms by restricting fi nance to them.  Recently, 12 firms were reported and had their loans either 
blocked or withdrawn.  For details of these measur es see MOFCOM online information.  Viewed at:  
http://www.mofcom.gov.cn. 
66 World Bank (2007b). 
67 The authorities are apparently having difficulty meeting the Government's target of reducing 
emissions of certain pollutants by 10% between 2006 and 2010.  According to the authorities, this is due mainly 
to:  rapid economic growth, which is outpacing improvem ents in energy and resour ce efficiency;  and weak 
enforcement of environmental laws.  Nonetheless, the authorities consider that positive results have been achieved, such as a 0.88% year-on-year  decline in the emission of sulphur dioxide in the first half of 2007. WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 14 
 
 
system, so that FIEs and domestic enterprises are placed on an equal tax footing, and launching pilot 
projects with a view to converting the current  VAT from a production-based into a consumption-
based tax.68   
23. At the same time, however, the Government c ontinues to use tax-based trade policy measures 
to protect the environment or reduce the current ac count surplus.  For example, while the VAT is 
generally levied at 13% or 17% , depending on the goods concerned69, VAT rebates in 2006 amounted 
to only 6.3% of total exports, thus falling well s hort of the full VAT rebate (with similar effect on 
exports as an appreciation of the exchange rate).70  Insofar as the rate of reba te falls short of the rate at 
which the VAT is levied, the difference constitutes a levy on exports.  VAT rebate rates may vary 
depending on products and thereby restrain exports of certain products, presumably to encourage or 
discourage exports or to ensure domestic supply, or, according to the authorities, for environmental 
reasons.71  Additionally, the authorities  introduced a 5-15% export tax on energy-intensive goods in 
November 2006 to reduce incentives to invest in the concerned industries, and to reduce exports (and 
thus the trade surplus).  To the ex tent that these levies reduce exports of the products concerned, they 
tend to increase their domestic supply and thus result in lower domestic prices of these products than 
otherwise;  this possibly assists downstream pro cessing of these products, without necessarily helping 
to improve the environment or reduce the current acc ount balance.  Consequently, the effectiveness of 
such trade policy measures in addressing the curre nt account surplus and environmental problems is 
questionable. 
(iii) Financial sector reform 
24. Since its previous Trade Policy Review, China h as continued to adopt measures to reform its 
financial sector with a view to establishing a smoot h-functioning capital market that would allocate 
savings to the most profitable investments, th ereby raising the productivity of capital and thus 
economic growth.  A smooth-functioning capital mark et is also key to tackling China's aging 
population, by ensuring that savings and pension fu nds can be invested with  the expectation of a 
reasonable return.  While financial sector reforms have helped to improve competition and thus the 
functioning of the capital mark et, major challenges remain. 
25. China's capital market remains heavily depende nt on the banking system, which is still under-
developed and relatively inefficient;  bank loans acc ount for 82% of total financing from the financial 
sector, and the equity and bond markets account for th e remainder.  The banking sector is dominated 
by four state-owned commercial banks, whose co mbined share of total bank assets was 55% in 2006 
(Chapter IV(5)(i)).  Leaving much of China's la rge domestic savings in th e hands of such banks, 
which have traditionally been the primary source of funding for SOEs, may have resulted in over-
investment in certain sectors, such as manufacturi ng and real estate, which appear to remain among 
the largest sectors to which these banks' have been  providing loans (Chapter IV(5)(iii)(b)).  At the 
                                                      
68 VAT is levied on the sale or import of goods and some services, and is production-based, thereby 
including capital goods in the tax base (unlike a consumption-based VAT).  Thus, capital-intensive industries 
are penalized. 
69 Reduction in the VAT rebates on energy- and resource-intensive goods were implemented, inter  
alia, in July 2007.  VAT rebate rates on goods considered to be energy inte nsive are now 0-5% compared with a 
VAT rate of 17%. 
70 See Whalley and Wang (2007a). 
71 By contrast, the business tax is a turnover tax on most services, levied at 3%, 5%, or 20%, depending 
on the service involved;  insofar as taxed services are themselves exported or embodied in exported goods, the business tax gives rise to cascading and thus also constitutes a levy on exports.  The consumption tax is 
essentially an excise tax levied at various combinations of ad valorem  and specific rates on certain items, 
notably cigarettes, alcoholic beverages, some refine d oil products including gasoline, and automobiles 
(Chapter III(4)(i)).  The consumption tax is fully rebated on exports.   China WT/TPR/S/199/Rev.1 
 Page 15 
 
 
same time, relatively limited access to financi ng through the growing, but still underdeveloped, 
capital market may have induced domestic private en terprises to rely heavily on retained earnings (or 
funds raised from family and friends).  This, along with seemingly weak corporate governance and 
minority shareholding rights, has apparently led to a steady increase in China’s corporate savings.  
More than half of China’s invest ment is financed from retained ear nings;  there is relatively little use 
of new share issues.72  However, with the recent reforms, th e authorities consider that China’s capital 
market has developed further, corporate governan ce of listed companies has been improving, the 
interests of investors have been protected, and the confidence of investors has been strengthened.73 
26. In order to create a more competitive banking sector, three of the Big Four state-owned 
commercial banks have been reformed/restructured since 2005;  nevertheless, management control of 
these banks remains in the hands of the State.  Th ere has been no institutional change in the largest 
state-owned bank, the Agricultural Bank, since Ch ina’s previous Review;  it is currently being 
converted into a joint-stock company.74  As a result of the restructuring of the state-owned banks, 
capital adequacy, asset quality, and NPL ratios have im proved (Chapter IV(5)(i)).  Nonetheless, there 
remain concerns regarding NPLs held by stat e-owned asset management companies and "special 
mention loans", which fall under a grey area between  normal and non-performing loans.  The former 
are a significant contingent liability for the Gove rnment, while the latter are vulnerable to an 
economic downturn and could add to existing NPLs.  
27. Since 2004, the securities market has also unde rgone reform and restructuring and grown 
rapidly, although the Government has recently tried to stabilize the growth by increasing stamp duty 
and prohibiting lending for investment in the equity markets.75  Apart from China’s overall economic 
growth and rapid growth in corporate profits, the reasons for the market growth appear to lie partly in the lack of other investment opportunities;  for exampl e, real deposit rates are low, investment in real 
estate is discouraged by the Government, and the lack  of flexibility in the exchange rate, coupled with 
capital controls, makes investment abroad or in foreign exchange denominated instruments difficult.
76  
As mentioned earlier, the authorities have taken steps recently to ease capital account restrictions, 
while also developing the domestic securities market  by reforming non-tradeable shares to tradeable 
ones, and establishing an investor protection fund (Chapter IV(5)(iii)(c)).  According to the authorities, the reform has been nearly completed;  the stocks of almost all companies can be traded 
on the stock market after a certain "lock-up period".  They consider that the reform has placed small 
and large shareholders on an equal footing, impr oved corporate governance of listed companies, and 
thereby substantially contributed to the growth of th e capital market in China.  In addition, to ensure 
better transparency and governan ce in the securities market, the au thorities implemented a risk-based 
supervisory system in August 2007.
77    
                                                      
72 Aziz et al. (2007). 
73 The authorities expect financing through the capital market to exceed Y 800 billion in 2008. 
74 In January 2007, Premier Wen Jiabao announced share holding reform in the Agricultural Bank of 
China as a first step toward its listing, although no time period was set.  Additionally, Central Huijin Investment 
Corp, the PBC's investment arm, announced plans to invest US$40 billion in the Agricultural Bank for its 
restructuring in August 2007 (China Economic Information Network online information.  Viewed at: http://www1.cei.gov.cn/ce/doc/cen2/200 708061035.htm [11 February 2008]). 
75 World Bank (2007a). 
76 The lack of flexibility in the exchange rate may deter investment abroad, as the exchange rate losses 
associated with a possible appreciation of RMB would negatively affect the return on such investment.  The 
enforcement of capital controls tends to be difficult;  such controls can be circumvented, for example, by 
transfer pricing. 
77 Information provided by the China Securities Regulatory Commission. WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 16 
 
 
28. Reform of the bond market is ongoing.  Reforms include the recent promulgation of new rules 
allowing qualified firms to issue corporate bonds, while the new Company Law abolishes the quota on the issuance of corporate bonds, thus making the bond market accessible for all qualified companies.
78  
29. The authorities have taken initiatives to allo w small and medium-sized domestic private 
enterprises (SMEs) better access to the capital market, such as the creation of a separate sub-board for 
SMEs in the Shenzen Stock Exchange in 2004.  As of December 2007, the SME board had 202 listed 
firms and a market capitalization of Y 1,052.6 billion.   
30. The recent move by the Government to require  SOEs to distribute dividends would tend to 
increase these enterprises' reliance on the issuance of new shares and corporate bonds to finance their 
new investments, and thus help support the de velopment of the equity and bond markets.  
(iv) Labour market 
31. A flexible labour market is a prerequisite  for the Government's policy objectives of 
maintaining strong economic growth and reducing inco me inequality.  Nonetheless, there is an overall 
surplus in the labour market in spite of labour sh ortages in certain areas.  It was estimated that 
in 2006, approximately 25 million people in China sought employment, while 11.84 million new 
urban jobs were created.79  In 2007, 12.04 million new jobs were created;  however, the authorities 
estimated that five million new graduates would join the labour force. 
32. In the longer term, China's ageing population is a concern, as 11% of the population (or 
approximately 144 million) are over the age of 60 (requi re pensions), with the figure expected to rise 
to 20% (290 million) by 2025.80  While this demographic change, with more people expected to leave 
than enter the labour force, could free up more jobs, it will also require higher labour productivity to maintain current economic growth.  
33. Certain employment restrictions under the "Hukou"  (worker registration) system have been 
relaxed to promote the development of rural areas  and address income inequality.
81  Nonetheless, the 
system still distinguishes between urban, rural, tem porary, and permanent workers.  This puts workers 
registered in rural areas seeking jobs in urban ar eas (migrant workers) at a disadvantage, as their 
entitlements to health care, housing, and education for their children, are not sufficiently provided for 
by the employers or local authorities.  
34. The All China Federation of Trade Unions (AC FTU) and the Central Government have made 
improved working conditions for migrant workers an important policy goal.  The Employment 
Promotion Law, which entered into force on 1 Janua ry 2008, aims to provide a legal framework to 
promote employment in China, while at the same time making it illegal to discriminate (for example with regard to gender, race, na tionality and religion) in employment.  A nationwide employment 
                                                     
 
78 Information provided by the China Securities Regulatory Commission. 
79 Among the 25 million, 9 million were first time j ob seekers including new graduates and "migrants" 
(from rural to urban areas), while the rest were largel y workers made redundant by SOEs (Asian Development 
Bank, 2006a and 2007). 
80 For women, the retirement age in China is usually 50 years old. 
81 It would appear that the Gove rnment recently relaxed the "Hukou " registration requirements for 
foreign-university graduates, who would be exempted from registration if they returned to China to work after graduation;  over 1 million students have gone abroad to study and only 25% have returned. China WT/TPR/S/199/Rev.1 
 Page 17 
 
 
assistance system is to be introduced.82  In addition, the Labour Contract Law, which entered into 
force on 1 January 2008, aims to strengthen the ro le of unions with regard to termination of 
employment;  the Law requires the use of labour contracts, and addresses collective contracts and 
part-time workers through separate clauses.  Furthermore, in January 2004, the Ministry of Labour 
and Social Security (MLSS) issued regulations that provided specific rules for the consultation 
process for collective contract bargaining.83  Other related laws and re gulations include the Minimum 
Wage Regulations (amended), whic h entered into force on 1 March 2004, and the Labour Law, which 
requires all workers to have contracts.84  
(5) DEVELOPMENTS IN TRADE  
(i) Composition of merchandise trade 
35. Between 2004 and 2007, merchandi se exports grew at an average annual rate of around 27%, 
to reach US$1,218 billion.  Exports are dominated  by manufactures, whose share in total exports 
increased from 91.4% in 2004 to 93.2% in 2007.  By contrast, the share of primary products declined 
from 8.4% to 6.6%, and the share of agricultura l exports from 4.1% to 3.2%.  The shares of 
comparatively low-value-added manufactures, such  as textiles and clothing , has also declined 
(Table AI.1).  
36. Imports have grown at a slower pace than e xports, at an average 19.4% annually between 
2004 and 2007, to reach US$955.8 billion (Chart I.1) .  The share of primary products as a proportion 
of total imports has been rising;  the impetus h as come from fuel, whose share of imports rose by 
2.4 percentage points (Table AI.2).  This increase is largely attributed to the rise in international crude 
oil prices;  the share of manufactures in total imports has declined.   
37. The robust growth of exports of manufactured products can partly be attributed to heavy 
domestic investment in manufacturing in recent ye ars.  This has resulted in new production (and 
export) capacity, especially in steel and machinery:  China has become a net exporter of steel, having 
previously been a net importer.  Additionally, a la rge portion of the increase in exports is apparently 
on account of higher value-added varieties of produc ts.  Between 1993 and 2005, the number of tariff 
line items China exported to the United States doubled.  As a consequence, half the increase in the 
value of China's exports is due to new categories of goods.85   Part of the slowdown in import growth 
can be attributed to import substitution and the broa dening of supply chains within China, as reflected 
in the decline in the ratio of imports  to exports in processing trade since 2005.86  
 
 
 
                                                      
82 Assistance may include:  tax reductions;  preferentia l loans;  subsidizing social insurance;  creation 
of jobs through public investment;  and assistance to particular areas where there is high unemployment due to 
the restructuring of the local economy and exhaustion of natural resources. 
83 At end 2006, 64% of 152,000 foreign firms were unionized. 
84 The Labour Law entered into force on 1 January 2005. 
85 World Bank (2006a). 
86 World Bank (2006b). WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 18 
 
 
Chart I.1
Product composition of merchandise trade, 2004 and 2007
2004 2007
(a)    Exports (f.o.b.)
Other consumer 
goods
15.9
Manufactures
91.4
Total:   US$593.3 billion Total:  US$1,218.0 billion  
(b)    Imports (c.i.f.)
Chemicals
11.7Iron & steel
4.2Transport equipment
4.2
Manufactures
76.3
Office machines &
 telecommunication 
equipment
22.9Other electrical
machines  
6.3
Non-electrical 
machinery
11.5Textiles
2.7
Other mining
  7.3Fuels
8.6Other
0.3
Other semi-
manufactures
3.1Machinery & 
transport equipmenta
43.2Chemicals
11.2Manufactures
70.9
Total:   US$561.2 billion Total:   US$955.8 billion Per cent
Manufactures
93.2
Machinery & transport equipmenta
47.4Iron & steel  4.2
Other electrical 
machines
7.2
Other consumer goods  
                      9.2Other
0.3Mining  3.4
Office machines & 
telecommunication equipment
29.0Textiles 
5.6Other
0.2
Other semi-
manuf. 
 7.7Agriculture
3.2
Iron & steel   2.3
Source :  UNSD, Comtrade database (SITC Rev.3), and General Administration of Customs (2007), China's
                Customs Statistics: Monthly Exports & Imports, 12, Series No. 220.              Other consumer goods
                   8.9
Mining
22.0Other consumer goods
14.9
Clothing   
9.5
Transport equip.
3.8Other semi-manuf.
7.4
Non-electrical
machinery
5.3
Other semi-manufactures
  3.8Mining
4.3Agriculture
4.1
Agriculture
6.8Agriculture
7.5
Mining
15.9
Iron & steel
2.5Clothing
10.4
Textiles
4.6Chemicals  4.4 Chemicals  5.0Other 
0.2
Textiles  1.7
Other mining
11.1Fuels
11.0
a              Including non-electrical machinery, office machines & telecommunication equipment, other electrical 
                machines, and transport equipment.
 China WT/TPR/S/199/Rev.1 
 Page 19 
 
 
(ii) Direction of merchandise trade 
38. The main destinations for China's merchandise exports are the EC-25, the United States, the 
SAR of Hong Kong (presumably involving largely entr epôt trade), and Japan (Table AI.3).  Since 
2004, the shares of exports to the EC-25 and the Unit ed States in China's total exports have changed 
marginally, from 18.1% and 21.1%, respectively, in 2005 to 20.1% and 19.1% in 2007.  By contrast, 
the shares of the Hong Kong SAR and Japan, as well as  Asia as a whole, have declined markedly. 
39. The main sources of China's imports in 2007 we re Japan (14.0%), EC-25 (11.6%), Republic 
of Korea (10.9%), Chinese Taipei (10.6%), and the United States (7.3%) (Chart I.2);  their shares in 
China's total imports have declined since 2004 (Table  AI.4).  On the other hand, the import shares of 
Africa and the Middle East have risen, presumably due to China's higher demand for energy and other 
natural resources.  
40. China is an export platform for the rest of Asia , as reflected in its bilateral trade balances.  
China runs a bilateral trade deficit with Asia as a wh ole, with particularly large deficits with Chinese 
Taipei, Korea and Japan.  On the other hand it has la rge surpluses with the United States and EC-25.  
This pattern of bilateral surpluses and deficits reflects China's role  as an export platform, especially 
for Asian countries, such as Japan, Korea and Ch inese Taipei, which export components to China, 
where they are assembled for export, particularly to the United States and EC.  
(iii) Composition of trade in services 
41. Services comprised 8.7% of China's total exports and 11.8% of its imports in 2006 (the latest 
year for which the full year data are available), co mpared with 9.5%  and 11.9%, respectively, in 
2005. Merchandise exports grew faster than servi ces exports, while services and merchandise import 
growth was almost the same. Travel, business, and transport were the main services traded (Chart I.3).  Imports of consulting services (research and developm ent) have been increasing rapidly, growing by 
approximately 32% in 2005 and 36% in 2006 to reach US$8.4 billion. 
(iv) Foreign investment 
42. China continues to attract considerable amounts of  foreign direct investment (FDI), much of it 
in export-oriented industries.  FDI has also been a major source of employment.  FDI in China 
decreased marginally, from US$79.1 billion in 2005 to  US$78.3 billion in 2006, or 3.5% and 3.0% of 
GDP, respectively.
87  The importance of FDI to the Chinese economy can be gauged by its stock of 
FDI as a share of GDP, which was nearly 21% in 200 6.  Furthermore, foreign companies in China 
accounted for over 57% of China's exports and 60% of imports in 2004.  Moreover, manufacturing 
FIEs accounted for 22% of GDP and 40% of Chin a's recent growth;  employing approximately 
24 million people (about 3% of the labour force), FI Es labour productivity is more than nine times 
that in the rest of the economy.88 
                                                      
87 The FDI numbers from SAFE are based on pledged amounts;  MOFCOM numbers differ as they are 
based on realized amounts. 
88 Whalley and Xian (2006). WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 20 
 
 
Chart I.2
Direction of merchandise trade, 2004 and 2007
2004 2007
(a)    Exports (f.o.b.)
Other Asia  
11.4Asia
47.6
Total:   US$593.3 billion Total:  US$1,218.0 billion
(b)    Imports (c.i.f.)
Free Zones
6.9Other Asia  
9.6EC25
12.5CISa  2.9
United States
8.0EC25
11.6CISa   2.9   Africa  3.8
Singapore  1.8
United States
7.3
Total:   US$561.2 billion Total:   US$955.8 billionPer cent
Asia
42.8
Other Asia  
12.3Middle East
3.6Japan
12.4
Middle East
5.1Korea, Rep. of
10.9Korea, Rep. of
11.1United States
21.1Other Europe  1.7
Other Asia  
10.3United States
19.1
Japan
14.0EC25
20.1Middle East   2.9
Asia
54.0Asia
56.8Japan
16.8
Free Zones
9.3Hong Kong, China
15.1
EC25
18.1Hong Kong, China
17.0Japan
8.4
Other America
5.8
Malaysia  3.0Chinese Taipei
10.6Chinese Taipei
11.5
Thailand  2.1Other America
4.4Korea, Rep. of
4.6Korea, Rep. of   
4.7
Other America
5.2Other America
6.5Middle East  3.9
Thailand  2.4 Singapore  2.5
a              Members of the Commonwealth of Independent States (CIS) are listed in Tables AI.3 and AI.4.CISa  2.3
Other Europe
1.2Africa  2.3CISa  3.9Africa  3.1
Other Europe  1.1 Other Europe  1.0   Africa  2.8
Malaysia  3.2Singapore   2.1 Singapore   2.4
Source :  UNSD, Comtrade database (SITC Rev.3), and General Administration of Customs (2007), China's
                Customs Statistics: Monthly Exports & Imports, 12, Series No. 220.              
 China WT/TPR/S/199/Rev.1 
 Page 21 
 
 
Chart I.3
Trade in services, 2004 and 2006a
2004 2006
(a)    Exports 
Business
32.0
Total:   US$62.4 billion Total:  US$92.0 billion
(b)    Imports 
Tourism
26.5Insurance & 
finance
8.7Business
19.5Transportation
34.0
Tourism
24.1Other
5.0Tourism
36.9
Insurance & 
finance
9.6
Total:   US$72.1 billion Total:   US$100.8 billionPer cent
Construction
3.0Tourism
41.2Other
2.4
Transportation
22.8
Source :   State Administration of Foreign Exchange onlin e information.  Viewed at:  http://www.safe.gov.cn/
                  model_safe/tjsj_detail.jsp [25 February 2008].Business
31.6
Computer & 
information
2.6Transportation
19.3
Construction
2.4Other 
2.5
Business
20.6Transportation
34.1Computer & information
3.2
Other
5.0
Royalties &
 license fees
6.6Royalties &
 license fees
6.2
a                The latest year for which the full year data are available.
 WT/TPR/S/199/Rev.1 Trade Policy Review 
Page 22 
 
 
43. In 2006, China's main source of FDI was th e Hong Kong SAR, which accounted for about 
one third of the total, followed by the British Virgin Islands (18%), EC-15 (8.5%), Japan (7%), 
Korea (6.2%), the United States (4.5 %), and Chinese Taipei (3.4%).  A significant part of the inflows 
from Hong Kong SAR and other sources (the British Vi rgin Islands, Western Samoa, and the Cayman 
Islands) presumably originated from other countries, including China itself, with part of such capital 
possibly being recycled through these territories (some of which are tax havens) in order to benefit 
from the preferential tax treatment offered by China to  foreign-based companies.  Part of FDI inflows, 
therefore, may involve "faked foreign investment" or "round tripping".89 
44. Outward FDI from China jumped from US$1.8 billion in 2004 to US$17.3 billion in 2006.90  
A large portion of the outward flow reflects China's e fforts to secure natural resources and fuel so as 
to be able to sustain its high growth rate.91 With China holding more than US$1.5 trillion in foreign 
exchange reserves (as of December 2007), the grow th in outward FDI looks likely to continue. 
(6) OUTLOOK  
45. With continuing strong growth in the latter half of 2007, China's annual growth rate was 
estimated at 11.4%, which was higher than the av erage rate achieved during 2003-06. Consequently, 
the Government's target of doubling GDP per capita in 2010 relative to 2000, as set out in the 
Eleventh Five-Year Plan, would appear to be within reach.  Furthermore, with its vast human resources, high rate of investment in physical and, to  a lesser extent, human capital, strong growth in 
labour productivity, and increasingly market-orien ted economy, open to international trade and 
foreign investment (and associated technology), Chin a has the potential to sustain its rapid growth in 
the foreseeable future, albeit at a somewhat slower rate as its economy matures and its labour force 
starts to shrink (largely as a result of its one-child policy).  In order to realize this potential, however, 
China needs to continue to address a number of important social and economic challenges, including 
various economic imbalances, which could je opardize the economy's stability and thus the 
achievement of a "harmonious society".   
46. First, there is the challenge posed by wide ning income disparities among regions and between 
urban and rural areas, one of the primary causes of which is wage differentials reflecting differences 
in labour productivity.  A related challenge is the need to facilitate the movement of surplus labour 
from relatively low-productivity agriculture into ot her activities, notably services, which tend to be 
more labour-intensive than manufacturing.  Mo reover, as growth in the labour force slows, 
technological progress will assume much greater importance as a source of economic growth and 
productivity improvement, so that China needs to con tinue to pursue its goal of substantially raising 
expenditure on R&D as a percentage of GDP.  China also needs to proceed with its plans to increase 
government spending on social services, such as health  and education, and thus  human capital, as well 
as basic pensions, thereby possibly reducing the n eed for precautionary saving and thus raising 
consumption.  These and other measures to incr ease consumption would not only reduce China's 
reliance on exports for growth, and hence its vulne rability to economic slowdowns abroad, but would 
also narrow the gap between national saving and gr oss domestic investment and therefore help to 
reduce China's large current account surplus. 
                                                     
 
89 Xiao (2004).  In addition to the preferential tax treatment of foreign enterprises, a reason given for 
such round tripping is that the Chinese authorities and the legal system offer better intellectual property rights 
protection to foreign companies.  Some estimates (Xiao (2004) and Dees (1998)) suggest that approximately 
20% of the FDI flows originating from the Hong Kong SAR are actually round tripping. 
90 State Administration of Foreign Exchange online in formation.  Viewed at:  http://www.safe.gov.cn 
[6 August 2007] 
91 During 2006 over 40% of China's outward FDI flow was in mining, while investment in mining 
constituted approximately 20% of China's outward stock (32% and 13%, respectively, in 2004). China WT/TPR/S/199/Rev.1 
 Page 23 
 
 
47. Another way of reducing China's high propensit y to save would be by channelling savings 
into the most profitable investments, thus impr oving the productivity of capital in the economy as a 
whole;  this requires ongoing reform of the capital ma rket to render it more efficient (and improve the 
transmission, and thus operation, of monetary po licy).  In addition, impediments to the efficient 
allocation of land, energy, water, and other natura l resources, such as price controls, need to be 
gradually dismantled;  this would help protect the environment, esp ecially if supplemented by market-
based tax and non-tax instruments, based on the "po lluter pays" principle, for example, to correct 
market failure.  There is also the challenge of tax reforms that would render the tax system (especially 
the VAT and enterprise income tax) more neutral with  respect to economic decisions, so that it raises 
sufficient revenues in an administratively simple  and equitable way in order to meet China's 
developmental needs, including expenditures me ntioned above, while minimizing consequent 
distortions in the domestic allocation of resources and trade. 
48. Although no forecasts of economic growth for 2 008 were available from the authorities, the 
World Bank envisages a slowdown to 9.6% owing to decelerating exports and a weakening global 
outlook.  Such a slowdown will bring the growth rate more into line with the Government's target of 
8%, something that macroeconomic policies, especi ally monetary policy, have hitherto proved 
ineffective in achieving.  Such a cooling of the economy could reduce inflationary pressure and 
contribute to its re-balancing.  Nonetheless, ther e remains the immediate issue concerning the ability 
of monetary policy to combat rising inflation.  In this regard, a more flexible exchange rate regime 
could enable China to operate a more independent monetary policy,  which would be better suited to 
ensuring a low and stable rate of inflation, and therefore contribute to a macroeconomic environment 
more conducive to sustained strong economic growth.  A more flexible exchange rate and thus more 
independent monetary polic y would complement structural reforms, especially those concerning the 
capital market, and obviate the need for price cont rols and other non-market measures to contain 
inflation.  There are signs that China's exchange ra te regime has become more flexible recently;  in 
January 2008, the renminbi appreciated nearly 1.6% in relation to the U.S. dollar, the largest monthly 
increase since the July 2005 reform of the foreign exchange regime.