Tuesday, April 26, 2005

Lawrance Lau and Joe Stiglitz, both economists, recently penned an editorial on FT arguing against RMB revaluation. Needless to say, this revived the whole revaluation discussion. There was one interesting aside this time as people mulled over the impact of revaluation on the PBOC's assets. Is it a simple matter of the PBOC taking a "hit" with devaluation? I try to elucidate, sort of, this matter below and once again make my usual anti-revaluation statement that the cost of the current course actually isn't that great:

The effect of revaluation on the PBOC's position is more complicated than a simple "hit" that it will take. On the other hand, I tend to think that the PBOC (or actually Wen Jiabao) has strong reasons to stay on the current course.

On the first issue of the PBOC's losses or gains in the event of a revaluation, I think China as a whole will gain from revaluation because, as some pointed out, China's international liabilities will decrease and purchasing power increase. For the PBOC, I think it will take an accounting loss since in the official PBOC balance sheet, foreign exchange reserve is an asset that is valuated in RMB terms. So, a revaluation would necessitate some kind of adjustment in its liability column, probably in the form of reduced currency in circulation as people exchange RMB for dollars. Although this would presumably have a negative impact on money supply, the PBOC can always counteract by buying back PBOC or gov't bonds to expand money supply (but would PBOC bonds be part of the PBOC's assets??).

As an aside, I wonder what would happen to the capital adequacy ratio of BOC, CCB, and now ICBC. In theory, they each received an injection from the foreign exchange reserve that went toward their core capital, so if their capital is denominated in USD, would revaluation all of the sudden decrease their capital?? I suspect not. I suspect that through some mechanism, the injections into these banks have been converted into RMB. Is it a simple matter of selling the dollars right
back to the PBOC? If someone knows the answer to this, it would be very enlightening.

Overall, however, I think Lau and Stiglitz are right that revaluation would further increase competition in the domestic goods and farm market as increasing purchasing power allow Chinese consumers and producers to look for options from abroad. Also, revaluation would have a negative impact on employment as wages rise (true, the effect might be small). At the same time, keeping the current course is actually less costly than most people think. Sure, there is enforcement cost and sterilization cost, but believe me, the PBOC has experienced far greater policy costs in the past than the current sterilization cost (just think issuing currency to pay for IOUs to farmers). As long as inflation is kept at bay, they can continue this for the near future, especially if oil prices pick up (actually, that's another interest issue, but basically China is using its foreign exchange reserve to subsidize cheap oil for domestic consumers). Finally, I tend to agree with Lau and Stiglitz's point about credibility. If you revaluate, you might invite more speculation, or, if you do it too much, there might be a flight from China.

The Lau-Stiglitz Editorial

Financial Times
China's alternative to revaluation
By Lawrence Lau and Joseph Stiglitz Apr 24 2005 19:12

China export taxWestern pressure has been mounting on China to revalue the renminbi, from hardening rhetoric in the US Congress to recent calls by the Group of Seven leading industrialised nations for more flexibility from China. However, there is currently no credible evidence that the renminbi is significantly undervalued, and an adjustment in its exchange rate at this time is neither warranted nor in the best interests of China or global economic stability.

The two symptoms of undervaluation are a large multilateral trade surplus or high inflation. China's measured trade balance has been in slight surplus (a surplus no doubt exaggerated by over-invoicing of exports and under-invoicing of imports); but with the volatility of oil prices and the international economy more generally, this could quickly be reversed. And while China's trade surplus has grown, China's multilateral surplus is far from the world's largest.

America blames China for the bilateral trade deficit; but America's trade deficits are a result of its huge fiscal deficits and the fact that Americans simply do not save. America's defence that it is doing the world a service by consuming vastly beyond its means is self-serving and rings hollow: US fiscal policies and low savings have become the fundamental source of global imbalances.

China has experienced large capital inflows (beyond foreign direct investment), but these are symptoms of speculative pressures that have been so destabilising throughout the developing world. It would be a mistake - and only a temporary palliative - to reward the speculators by appreciating the currency.

Some in China would revalue the currency not because they believe there is a fundamental economic problem, but to get the Bush administration off their backs. But currency appreciation is not likely to reduce significantly the US balance of payments deficit with China or the world. Because the prices China pays for imports would be lowered, and because of the high import content of China's exports to America - as much as 70-80 per cent - even a 10 per cent revaluation would have miniscule effects. Moreover, China should receive some comfort from having joined the World Trade Organisation: there are the beginnings of an international rule of law. A unilateral imposition by the US of import duties would most likely contravene WTO rules; it is hard to call a country that has adopted a fixed exchange rate system a currency manipulator.

If China were to contemplate a revaluation, it should consider as an alternative the imposition of a tax on its exports. Export taxes are generally permitted under WTO rules. Indeed, China has already moved in a limited way in this direction on textiles. There are several reasons voluntary imposition of a tax on its exports may be preferable to a renminbi revaluation. Both would have similar effects on Chinese exports - they would make them appear more expensive to the rest of the world. Because of this similarity, an export tax would provide an empirical answer to the question of whether a revaluation would work. But it would do this without some of the significant costs attendant on revaluation.

One of the advantages of an export tax is that, unlike a revaluation, it would not lead to financial losses for Chinese holders of dollar-denominated assets, such as the People's Bank of China or commercial banks and enterprises. China's central bank currently holds about $640bn in foreign exchange reserves. Assume that only 75 per cent is held in dollar-denominated assets. A renminbi revaluation of 10 per cent would result in a loss of $48bn or about 400bn yuan for the central bank.

Another cost of revaluation would be possible further deterioration in the distribution of income, in cluding increasing the already large rural-urban wage gap. Revaluation would put downward pressure on domestic Chinese agricultural prices; an export tax would not. An export tax, by contrast, would have a beneficial side effect: it could generate substantial government revenue for China. Given the high import content of Chinese exports to the US, a 5 per cent export duty would be equivalent to a currency revaluation of some 15-25 per cent, generating about $30bn-$42bn a year.

Finally, an export tax would not reward currency speculators. It may even discourage the speculation that has com plicated macro-economic management of China's economy. If potential speculators can be convinced that China would rather impose an export tax than revalue, less "hot money" will flow into China. By contrast, nothing encourages speculators more than a "victory", especially where, as here, it is likely to do little to correct the underlying problems.

An export tax can be easily lifted if and when Chinese balance of payments conditions so warrant. It could be stipulated that the tax would be reduced or lifted if the Chinese current account balance turned significantly negative. America's China policy has been driven more by domestic politics than hard economic reasoning or thoughtful, quiet diplomatic initiatives.

It would be better for the world if the international rule of law prevailed - and within those rules, China could unilaterally impose an export tax, while it is dubious whether America could impose an import duty. Most importantly, we should not let bad politics drive out good economics.

Lawrence Lau is professor of economic development at Stanford University and vice-chancellor at the Chinese University of Hong Kong; Joseph Stiglitz is University Professor at Columbia University and Nobel laureate in economics

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Friday, April 22, 2005

The central government recently approved ICBC's plan for restructuring, again in preparation for its eventual listing. To help ICBC in its restructuring, the central government will inject some 15 billion USD from its foreign exchange reserve (currently totally 659 billion USD) into ICBC to increase its capital adequacy ratio from the current 4.77% to around 6%. International financial rules typically requires a capital adequacy ratio of 8%. Is this injection any different from previous bailouts of Big Four state banks? What are the implications of this bailout?

First, the ICBC is in more trouble than were the Construction Bank and the Bank of China. Becacuse ICBC historically took charge of financiang SOEs, it still has an official NPL ratio of around 20%, or roughly 700 billion RMB. At the same time, its CAR is still relatively low. Thus, the State Council has to clean up ICBC in a two-part process, both likely involving injection from China's foreign exchange reserve. The current injection is merely the first step in a two-step process of preparing ICBC for listing. First, banks find a way to increase capital adequacy ratio, which in the case of CCB and BOC was accomplished through good-old-fashion profit accumulation. Both ICBC and BOC had capital adequacy ratio above 6% in early 2004, with BOC having a CAR well above 8%. In the case of ICBC, the central government sped up the recapitalization process with a forex injection and with issuance of subordinated debt. The second step will be to reduce the store of NPLs. It is in this second step that CCB and BOC received the 45 billion injection. The two banks also got to off-load some 350b RMB in NPLs to the AMCs. I suspect ICBC will undergo a similar process. With China's foreign exchange reserve continuing its upward climb, ICBC will enjoy another forex injection and, for sure, ICBC will transfer a big slice of NPLs to AMCs, probably around a half of their current NPLs, or 350 billion RMB.

Thus, ICBC enjoyed a greater "free lunch" than did BOC and CCB. While BOC and CCB have had to work hard to build up profit every year in order to bulk up their capital, ICBC now receives substantial injections with hardly any improvement . I think this is the wrong move on the part of the central government. Instead of speeding up ICBC's IPOs-- although I believe that the injection into the BOC and CCB was justifiable-- why not set profitability targets for ICBC in the next few years and allow ICBC to slowly build up a capital base? By speeding up restructuring with what will be two foreign exchange injections, the central government merely encourages ICBC officials to rely on central bailouts instead of working harder to change corporate structure and culture. Also, the global capital market will not have a large enough appetite to buy shares from all three banks in the near future anyway. Through this accelerated restructuring process, those in charge of finance are looking to increase their "administrative accomplishments" before the 17th Party Congress. Once again, politics trumps sound economic logic in China.


央视国际 2005年04月22日 16:38


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Thursday, April 14, 2005

Well, rumors of SOE share sell-down are resurfacing as China's stock regulator think of ways to battle the persistently bearish stock market. Recently, a report suggests that the CSRC is thinking about selling off some of the state and legal person shares in the stock market for a selected group of companies. Now the FT just published an editorial by Fang Xinghai, veteran financier and vice head of the Shanghai Stock Exchange, in which he suggests the same. As he put it, it will be a bitter pill as investors expect a short-term fall of stock prices, which will trigger a panic sell-off. But in the long-run, it is the only way to get China's stock market back on the road toward a well-functioning market. So, this makes me wonder whether China's leaders will coordinate the sell-down annoucement with the announcement to revaluate the RMB. In the short-run, an announcement to revaluate the RMB would attract foreign capital to China, a part of which would enter as QFII money to the stock market. At the same time, an announcement to sell down SOE shares will trigger an investor panic in the short-run. Perhaps I am wrong, but revaluation might dampen the bearish pressure of a sell-down announcement. Readers can decide if this makes sense.

From Fang Xinghai of the SHSE


China's weak link - Capital market reform will take years. Why not start now?
498 words
14 April 2005
Financial Times
Asia Ed1
Page 12
(c) 2005 The Financial Times Limited. All rights reserved

The fragile banking sector is not the only problem that ought to give Chinese leaders sleepless nights. There are also the country's stock markets.

The days are long gone when the rising markets of Shanghai and Shenzhen threatened to eclipse Hong Kong as the listing location of choice for the best Chinese companies. Although a handful of locally listed companies have prospered, the markets as a whole have fallen since 2000. Last year, the Shanghai composite index dropped 15 per cent, making it one of the world's worst performers in spite of Chinese economic growth of 10 per cent.

Instead of complementing bank lending by giving companies another way to finance growth, the stock markets weigh on the banks; many brokers are near bankruptcy and thousands of irate retail investors are in debt.

In the short term, a plan by the China Securities Regulatory Commission to forge ahead with privatisation by reducing the state's shareholdings in listed companies could make matters worse. The pilot schemes being mooted to sell more shares in state companies - in which the state has typically kept a 70 per cent stake - will remind investors how much unsold stock is hanging over the market. Fewer than one-tenth of Chinese listed companies are from the private sector.

There is, however, no other obvious way to begin. Investors have been aware that the overhang has existed since state companies first began listing minority stakes. China must not balk at doing what is required.

That does not mean that this inevitable round of further privatisation will be easy. Managers of state companies, some of them corrupt, have come to see a listing as an easy, one-off form of capital-raising to finance ailing operations. Too few have understood the true purpose of the markets, which is to finance enterprise and to reward investors for the concomitant risk.

A tougher official attitude - leading to heavily discounted share sales by shoddy state companies, better opportunities for private entrepreneurs and strict regulation of brokers - will face political resistance, especially from cities and regions where the worst companies and brokers are based.

But it is essential that the stock markets in Asia's most dynamic economy be made healthy. Private sector companies need capital, and China's future pensioners need liquid shares in a range of blue-chip companies in which funds can invest on their behalf.

Along with the banks, the capital markets are the weakest parts of a Chinese economy renowned for rapid economic growth and the prowess of its manufacturing industry. If China fails to get this right, shareholder capitalism could be delayed for another generation. Pensioners would lack a reliable source of income, and capital for dynamic Chinese companies - the ones that should be taking the economy to the next level of development with investments in high technology and services - will remain all too scarce.

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