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The adjustment of China’s growth strategy and macroeconomic stability Yu Yongding Institute of World Economics and Politics The Key features of the East Asian model High investment rate supported by high saving rate and capital inflows Running current account deficit, but having a high growth rate of exports The sustainability of the East Asian Model conditional on Current account deficit/GDP ratio Net foreign debt/GDP ratio There should be a point of model–shift, when the economy reaches a new stage of development The vulnerability of the East Asian Model: susceptible to sudden reversal of capital flows The key featurs of the Chinese model High investment rate supported by high saving and FDI inflows Trade promotion A competitive exchange rate Domination of state-owned banks in financial intermediation Capital control The merits and demerits of the Chinese model The strong point of the Chinese model: Not vulnerable to external shock. With 1.2 trillion Fx reserves, It is difficult to envisage how a balance of payments crisis and a currency crisis can possibly happen to China The weak points of the Chinese model: Double Misallocation of resources As a result, the number 128 poorest country in the world becomes the third largest capital exporting country in the world While running huge current account surplus, its investment income is in deficit (in sharp contrast to Japan) Twin surpluses+ inflexibility = excess liquidity China’s twin surpluses 200 bil + 60 bil 250000 150000 100000 50000 current account FDI 20 06 20 04 20 02 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 -50000 19 84 0 19 82 In USD Millions 200000 The increase in foreign exchange reservers 12000 10000 8000 6000 4000 2000 200 bil a year 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 0 Rewards for being a debtor Punishment for being a creditor: China’s current account surplus and investment income deficit 180,000 160,000 140,000 120,000 100,000 80,000 Current account Investment income 60,000 40,000 Due to appreciation expectations 20,000 0 1999 2000 2001 2002 2003 2004 2005 -20,000 -40,000 Except for 2005, over the past 25 years, investment income balance has always been in deficit Japan’s investment income account surplus since it has run current account surplus Twin surpluses mean misallocation of resources The 128th poorest country in the world, the third larget capital export country in the world The 3rd largest FDI attracting country, fails to translate capital inflows into current account deficit The USD1.2 trillion foreign exchange reserves represent a huge subsidy to the US Why China should be worried China’s growth relies on the high investment rate supported by the high saving rate China’s high saving rate, in the long run, is attributable to the low dependency ratio China is aging. “Demographic dividend” will disppear in 15 years Need investment income surplus to supplement deficiency in saving, otherwise China will not be able to maintain a decent investment rate. Japan’s investment income surplus has surpassed trade surplus since 2005 Six stages of economic development: where is China i investment IV III s V II VI saving I Net worth 投资收入 0 Current account ca Investment income Stage China is in Trade balance With positive net worth, Investment income is in deficit, which implies that investment income may not be enough to supplement savings in the future when China is aged. A comprehensive policy mix has been adopted to address the abnormal pattern of international balance of payments Combination of fiscal policy and monetary policy to stimulate domestic demand More decent public goods, to stimulate consumption Abolishing market distorting preferential policies to reduce twin surpluses Exchange rate policy Address Deterioration of Environment Exhaustion of energy Widenning gap between the rich and poor and different regions Instability of the Economy Current account surplus continues to increase Equity price is soaring Inflation rate is approaching the implicit target growth rate of investment continues to be significantly higher than that of GDP Equity bubble 100 million retail accounts (maybe half of them are active) 200,000-300,000 new accounts a day since April Price has tripled in less than 2 years From 2000 to 3000: 18 months From 3000 to 4000: 31 working days Turnover supassed London, Japan+13 major Asian economies in some trading days in May Number of daily transaction is 18 times of that of Hong Kong P-E ratio doubles the international level Control of Excess liquidity holds the key Given the momentum of current account surplus To achieve the objectives of controlling inflation assets bubble slowing down the growth rate of FAI excess liquidity must be mopped up The sources of excess liquidity High M2/GDP: 160% (previously frozen) The growth rate of M2 has been consistently much higher that of GDP (“tigher” in the cage is out) The most important componen of M2 is household deposits receiving very low interest (the real rate more often than not below zero) Attracted by much higher capital gains in the equity market Tiger is out (in April 170 billion household depoists left banks and entered the equity market twin surpluses (newly created) $250 billion twin surplus Trade surplus and normal capital inflows Speculative capital inflows (what is the proportion?) aimed at Assets Capital gain Revaluation expectation + carry trade PBOC intervention aimed at RMB stability Increase in commercial banks’ deposits with the PBOC— Reserves Fully sterilization is difficult (why?) M2-GDP ratios of different countries 160.0 China P.R. Brazil Japan Ratio of Money to GDP (%) 140.0 India Poland Korea Indonisia United States Germany 120.0 100.0 80.0 60.0 40.0 20.0 0.0 1978 1980 1982 1984 1986 1988 Year 1990 1992 1994 1996 1998 Policy measures used to mop-up the excess liquidity To sell central bank bills to commercial banks To raise reserve requirments To raise interest rate The constraints on sterilization The negative impact on commercial banks’ performance Resulting higher interest rates may attract more capital inflows The impact on the real economy may be too great 20 05 . 20 01 05 . 20 02 05 . 20 03 05 . 20 04 05 . 20 05 05 . 20 06 05 . 20 07 05 . 20 08 05 . 20 09 05 . 20 10 05 . 20 11 05 . 20 12 06 . 20 01 06 . 20 02 06 . 20 03 06 . 20 04 06 . 20 05 06 . 20 06 06 . 20 07 06 . 20 08 06 . 20 09 06 . 20 10 06 . 20 11 06 .1 2 Central bank bills/total assets rate is increasing steadily 40000 20000 0 12.0 35000 10.0 30000 25000 8.0 6.0 15000 4.0 10000 5000 2.0 0.0 央行票据 在商业银行资产中的占比(%) reserve requirments are increasing steadily time adjustment 2003(09/21) 7% 2004 (04/21) 7.5% 2006 8% 2006 8.5% 2006 9% 2007(01) 9.5% 2007 (02) 10% 2007 (03) 10.5% 2007 (04) 11% 2007 (05) 11.5% Impact of sterilization on commercial banks’ profitability Share of low yield assets over total assets may have surpassed 20 percent The gap between deposits and loans is huge rate × total lending – deposit rate × total deposits = 90 percent of total bank profits Sterilization reduce the ability of lending by banks and hence their profits Lending in 2005 finanical instituts held 28.7 trillion deposits and extended 19.5 trillion loans. The gap was 9.2 trillion, accounted for more than 30 % of deposits To compensate the losses, more reckless lendings (equity speculation) Recent PBOC policy annoucement Increase the band of floating from 0.3% to 0.5% Increase reseve requirements from 11% to 11.5% 27-basis-point (bp) hike in the deposit rate , lending rate hike is smaller for the first time. Monetary policy is not enough Continue to sterilize to mop-up Lure the money back banks to contain equity bubble Failue of the policy Too small But if bigger, how about the real economy Fiscal policy (stamp tax) Government should not be fear of intervention (assets price zone) Lack of flexibility of exchange rate is a foundamental cause of excess liquidy, independece monetary policy is needed Why pace for RMB exchange rate appreciation is so slow: textile, 19 million, 3.5% profitability, massive unemployment Will the pace of appreciation speed up? It depends on Development of current account surplus Development of inflation and assets bubble Growth of FAI Sustainability of sterilization operation Effectiveness of the management of capital account A more positive attitude towards appreciation should be adopted RMB should be revalued to Help to reduce trade surplus,which is more than we need Provide enterprises impetus for upgrading their positions in the value chains Improve terms of trade Reduce trade frictions To share the burden of reducing excess liquidity, so that the PBOC could enjoy more freedom in conducting monetary policy Illusion should not be given to enterprises so that time will not be wasted and opportunities will not be lost Concluding remarks Adjustment of growth strategy Macroeconomic stability Deepening the reform Promising future