Wednesday, February 11, 2004

To revaluate or not to revaluate, that is the question. Okay, that was cheesy, but it is a serious topic of discussion. There are two pieces on the topic lately, one saying that China will revaluate, the other denying it. I just thought of what the Chinese might do:

I agree that Wen's remarks leave considerable room for interpretation. However, if he is concerned about inflation now, any move toward revaluation would increase the flow of hot money into the system, as the PBOC's credibility against revaluating would be ruined. Instead of relieving pressure, a revaluation now might motivate people to sneak even more dollars into the economy. One thing they can do is to revaluate (or loosen the band) while doing something major to slow the flow of dollars into the economy simultaneously. The increase in taxes for FIEs is one move, but it isn't surprising. Another possibility is using a large chunk of the forex reserve to buy oil, which would also drive up cost to export industry.

The two articles:


Wednesday, February 11, 2004

Premier vows to keep stable yuan exchange rate

Wen Jiabao says he will also place controls on sectors that are growing too fast

Premier Wen Jiabao has pledged to maintain a "basically stable" yuan exchange rate as Beijing comes under mounting international pressure to revalue the currency.

And for the first time he has expressed serious concern about over-investment and overheating in the economy, promising to place controls on bank lending to sectors that are growing too fast.

The mainland would gradually perfect the yuan exchange rate formation mechanism and maintain the basic stability of the currency at a reasonable and balanced level, he was quoted on CCTV as telling a high-level national financial conference which opened in the capital yesterday.

His comments indicate that Beijing is unlikely to revalue the yuan at a higher level against the US dollar soon, despite media speculation to the contrary.

On Monday, the People's Bank of China, the central bank, denied a report by a mainland business newspaper that Beijing could increase the value of the yuan by 5 per cent in March and by 10 per cent later this year or early next.

The report came amid thinly veiled calls at the weekend by the G7 group of rich nations for the mainland and other Asian countries to move towards more flexibility in their exchange rate policies.

The US has been leading the campaign by western countries to pressure the mainland to lift artificial controls that fix the exchange rate at about 8.28 yuan to the US dollar. America has blamed a cheap yuan for flooding its markets with cheap imports, causing job losses.

Mr Wen told the conference there had been new problems in the economy. These included over-investment in some sectors, serious duplication of low-level industrial projects, a shortage of energy resources and raw materials, and excessively rapid growth in money supply, with inherent risks to the financial system.

He promised controls on bank lending to sectors that already had too many investments. Although he did not mention any by name, officials have said the central bank has ordered commercial banks to reduce lending to the car-making, steel and property sectors.

Mr Wen said the government would speed financial reforms, with a focus on restructuring the Bank of China and China Construction Bank into shareholding entities. The two state banks have targeted overseas listings this year and next.

Wu Dingfu, chairman of the China Insurance Regulatory Commission, said yesterday it had begun a feasibility study on allowing mainland insurance funds to invest in overseas bond markets. This appears to mark the start of the long-awaited Qualified Domestic Institutional Investor scheme, under which the mainland will allow domestic investors to place funds in overseas capital markets.

China Is Said to Consider Revaluing Its Currency

Published: February 10, 2004

BEIJING, Feb. 9 - A report in an influential Chinese financial newspaper has fueled speculation among bankers and economists that the Chinese government is considering revaluing its currency over the next few months.

The report, which appeared in the weekly China Business Post over the weekend, quoted unnamed Chinese central bank officials as saying the government may allow the currency, the yuan, to rise by as much as 5 percent in value against the dollar as soon as March.

Officials from China's central bank dismissed the report on Monday. "This is the newspaper's opinion; it isn't a central bank decision," an official from the bank told Dow Jones Newswires.

But economists and analysts here said that the central bank's denials left open the possibility that it was drawing up plans for less immediate changes to loosen the peg that has welded China's exchange rate to the dollar since the mid-1990's.

"It's notable the debate is moving from being an international one to a domestic one," said Chen Xingdong, chief economist for BNP Paribas Peregrine Securities in Beijing.

The China Business Post cited bank officials and experts as saying that the yuan may be allowed to rise in value next month within a 5 percent band, and that over the coming year China may broaden the band in which the currency can fluctuate.

"If the central bank decides to adjust the yuan's exchange rate, it is quite likely this will enter a substantive stage next month," the paper said.

By late this year, the fluctuation band may widen to 10 percent, eventually leading to a freely floating exchange rate, the paper said. Since 1994, the yuan has been virtually tied to an exchange rate of 8.27 yuan to the dollar, with only a hairbreadth trading band of 0.3 percent.

The China Business Post is, like all Chinese newspapers, government-controlled; it comes under the sponsorship of China's stock exchange authority.

Last year, as China's trade surplus with the United States topped $120 billion, a succession of Bush administration officials lobbied the Chinese government to allow the yuan to rise against the dollar, which would make China's exports more expensive.

Chinese officials, including the prime minister, Wen Jiabao, have said that China will gradually adjust its exchange rate policies. But the weekend report was the first to suggest changes are mere months away.

Finance officials in Beijing denied the China Business Post report, and the central bank's spokeswoman, Bai Li, said that it was "fabricated." But the officials' comments also left open the possibility that China is drawing up longer-term plans to ease international friction about its exchange rate policies.

"The most important thing is maintaining the stability'' of the currency, the central bank's monetary policy director, Yi Gang, told Agence France-Presse. As to when the exchange rate changes could take place, "there is no clear timetable," he added.

The official Xinhua News Agency reported on Monday that China might tie its exchange rate to a set of 10 currencies, weighted to reflect their respective importance in China's trade and investment inflows.

The news comes as the Group of 7 industrialized nations said over the weekend that "more flexibility in exchange rates is desirable for major countries."

Revaluing the yuan against the dollar would ease international pressure on China to rein in its exports and would make imports of steel, cotton and other important manufacturing items cheaper, but it would also dampen China's exports and foreign investment inflows, bankers and economists said.

"This is a political decision in the end," Mr. Chen, the economist, said, "because whoever does it also has to bear responsibility for the problems, as well as the gains."

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Tuesday, February 10, 2004

This guy at CEQ asked me some questions on recent monetary policies, and here are my answers:

1) The CBRC issued a notice on 2/8 saying it will launching a probe into
loans made into overinvested industries like autos, steel, cement and real
estate, which are at risk for having serious overcapacity. Those being
investigated reportedly include state banks down to the rural credit
cooperatives. Can you tell me how you think a probe like this typically
works? And how successful do you think it will be?

The main purpose of this probe is to ensure that loans going into over-heated sectors were made according to regulations (both internal bank regulations and CBRC regulations). Very often, when a sector is over-heated, banks would rush in and give loans without doing all the necessary evaluation. As the CBRC edict states, the first step involves internal review by the banks, which is essentially useless. The second step involves on-site audits from local CBRC branches. It is expected that the local CBRC branches will mostly do the bidding of the central CBRC since CBRC is run vertically with little direct local governmental intervention. What is happening behind the scene, however, might be actual lending quotas on banking lending to various industries. This was a common practice in the past, and the government is trying to get away from it. However, CBRC still has full authority to impose lending quotas on the Big Four banks. You should ask around to see if this is indeed what's happening.

2) China has relied heavily on export growth and investment in fixed assets
over the years. What are some of the most severely overinvested parts of the
Chinese economy? Can you give me some examples of how overinvesrtment could
create serious problems?

Besides possibly causing inflation (over-investment also causes a supply bottleneck which exacerbates inflation), overinvestment was the cause of much of China's NPL problem. The perfect example was the real-estate bubble in 93-95. Essentially, local governments and companies borrowed heavily from banks to finance real-estate development expecting property prices to rise. When it didn't, banks were left with a lot of NPL and empty apartments. This is part of what the AMCs are trying to sell off at the moment. If the situation repeats itself, NPLs will get another major boost. Granted, even if there is a real-estate bubble (there is a debate on this) and even if it bursts, the magnitude of the problem as a % of GDP will not be as bad as in 1993. Loans to real-estate are no longer such a large % of bank lending, which has diversified to include consumer loans. Also, loans are now made to buyers, whereas loans before were made to real-estate developers. In the worst case scenario, I think the bursting of a real-estate bubble, even if there was one, would only increase NPL ratio by 5-10%.

3) Before the CBRC notice, Chinese Vice Premier Zeng Peiyan spoke of some of
these risks last week. Do you think China's leaders are starting to admit
this problem could be serious if left unchecked? Aside from probing
excessive and improper lending in these industries, what are some of the
other moves they can take?

In the past few inflationary cycles, targeted loan restriction usually constitutes the first step toward thwarting inflation. The problem with targeting specific industries is that money is fungible, so other companies can borrow from banks and re-lend to the over-heated sectors. The next step is more general efforts to control money supply, including raising interest rates and imposing a general credit quota on banks. The government is reluctant to raise interest rates because it would increase the cost of capital for restructuring SOEs and the cost of financing the deficit. Thus, it might resort to general credit control next. The debate on whether there is a inflationary problem is now just beginning. The Wen administration is not sure whether it wants to crack down on inflation yet because it is currently providing the benefit of enriching the farmers. Much of the current inflation stems from rise in food prices, which is good for farmers. I think the current administration is willing to see inflation rise to 5% before taking more drastic measures. This ambiguous attitude, however, sends the signal that more lending is still okay. Thus, despite the CBRC probe, I don't expect lending to slow down significantly in the first half of this year.

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