Asia holds sway over mainland growth
What is your forecast for the mainland's economic growth this year? A: The days of a fixed target, as in the past, are over. This year the government's number is 7 per cent, which is a projection for the centre of a range. Seven per cent is reasonable. The external environment is less predictable, especially the rebound of trade volumes in Asia.
If the Asian economies . . . recover slowly, then 7 per cent is reasonable. If the Asian economies do worse [than last year], it could be 5 per cent. If they recover well, it could be 8 per cent or even more.
Q: How much will the government's giant infrastructure package, announced in the middle of last year, add to economic growth this year? A: It could account for 1.5 to 2 per cent of the 7 per cent.
Q: What is your forecast for the mainland's trade performance this year? A: There may be a decline in the trade surplus to about US$20 billion to $25 billion [from $43.5 billion last year], and in the current-account surplus to about 1 per cent of gross domestic product from 2.5 per cent of GDP last year. But, if the external environment is less positive, the current-account surplus could even fall to $5 billion or zero.
Q: Should Beijing maintain the level of the yuan? A: The government rightly maintained the level last year and has not said anything to change that. There is no good economic reason to change. China still has a trade surplus and inflation is negative.
Given that its trading partners are experiencing inflation, this has already made China more competitive. Price is not the issue, the issue is demand. A devaluation would convey no significant economic benefits.
Q: Why do many abroad keep saying Beijing will devalue? A: There is a herd instinct which can create panic in the market and market perception can make a big difference. This perception can be based on emotional feelings or real economic reasons. I think it is about 50-50.
There is a wide audience that does not understand that China's external situation is different from that of other countries in Asia - its short-term borrowings are low and its capital market is closed.
Yes, its banks have a large burden of bad loans but putting money in the bank is like depositing it in the Ministry of Finance. The banks, like the ministry, will not disappear, despite the non-performing loans. In other Asian countries, banks are private and can disappear.
When financial institutions have been closed in China, the deposits of private individuals have been repaid or transferred to a stronger institution.
Q: How do you evaluate Beijing's management of Guangdong International Trust and Investment Corp (Gitic)? A: This is a very difficult situation. It is very sensible that, after the Asian crisis, the government does not want loans to be given on the basis of an implicit government guarantee. Foreign and domestic lenders should be treated the same, this is a good principle.
With the flow of money in and out of China, with Chinese money going to Hong Kong and then being re-invested in China, we cannot tell which is foreign and which is domestic.
The problem is that creditors do not know how the debts will be settled, how long it will take nor what preferences they will get.
We do not know because we have not gone through this [bankruptcy of a financial institution] before [in China] and we do not know what Gitic's real assets and liabilities are. It will take time. China should bring the creditors into the process and make it more transparent and, if they become part of the process, they will feel less uncomfortable.
Q: Will the mainland close more international trust and investment companies (Itics)? A: There are good and bad Itics. The data and information base is messy. Many Itics have a lot of bad loans and there will be losses. This is essential to a major reform of the financial sector. It is a signal to banking entities that they will be held accountable for their losses, that is the lesson from the Asian crisis.
Foreign borrowers will become more cautious and reduce their exposure but, if such loans were not grounded on sound principles in the first place, this is a sensible outcome. More Itics will probably be closed and merged.
Q: Why did the mainland's foreign exchange reserves rise by only $5 billion last year to $145 billion when it had a surplus during the year, in trade and foreign investment, of more than $80 billion? A: Much of this can be accounted for in the services and capital accounts and the rest under the 'errors and omissions' column. A significant amount of money cannot be easily accounted for.
When China's reserves were rising very fast, it liberalised the system to let companies hold more foreign currency. But, during the Asian crisis, it switched course and imposed more controls on the movement of this foreign currency. Firms that had become used to a more flexible policy were faced with a reversal and were reluctant to bring the money back.
China's trade volumes are several times what they were just a few years' ago. To match this increase, the foreign exchange held overseas should increase to handle all the transactions, just as a department store that doubles its turnover must keep much more money in the till.
When you have a closed capital account and an open trade account, such discrepancies show up as capital flight. Such movements are reasonable. I do not see a major problem here. The $145 billion [in reserves] are twice what they were two years' ago. Some decline this year would be reasonable and we should not be worried about it.
China needs to explain to the world that, when it stimulates the economy, this could mean a slight decrease in the reserves, because stimulating demand will increase imports. This is about managing expectations. A drop in reserves to $141 billion or even $135 billion or less should not be an issue, although, if unprepared, the market might think it is an issue.
Q: What should the government do to stimulate consumer demand, a key component of overall demand? A: It has been extremely difficult to stimulate consumer demand in Japan and the same is true in China.
The government can take steps in four areas. One is to improve household security, by providing more social protection to ease concerns people have over being laid-off and to encourage them to spend. We estimate that these programmes are under-funded in some provinces, perhaps in the range of 0.5 per cent of GDP.
The government could provide more transfers. The problem is that provinces cannot run budget deficits and it is hard to find ways to fund these programmes.
It should do more on housing reform, transfer more homes from the state to citizens and give people more freedom to rent and sell homes.
Housing costs can be cut. Material and labour costs account for only about half or less of total costs, with the rest accounted for by permits, fees and the land price.
There are ways to promote growth in rural incomes and consumption. The government has tried to address this issue by supporting grain prices, but this is not sustainable as it leads to more stock.
We see the answer in farmers shifting to other, more-profitable crops, and if so, incomes will increase naturally.
The government can increase spending on rural infrastructure, for example on rural power, which would increase consumption, and on feeder roads, which have been under-funded compared with national highways which are easier to build because they are financed by tolls. Feeder roads would provide links to markets and stimulate the economy.
There is tremendous potential to increase jobs and demand in the service sector.
We have found that the proportion of service-sector jobs in China is only half what it is in other low- and medium-income developing countries.
The service sector is a major source of job creation, so China should encourage it and be more flexible in opening entry in sectors such as finance, accounting, travel, tourism and insurance.
Q: Should Beijing not open these sectors to foreign companies? A: In some sectors, it is a win-win for both Chinese and foreign firms, in some areas Chinese participants stand to benefit immediately.
The financial sector will not be opened up until local banks can compete better. Foreign banks should help domestic banks and this would help to open the sector.
In telecommunications, the controversy is the same as it was in Eastern Europe. Opening up telecoms is difficult in the absence of a clear regulatory framework and competition.
Q: Many Chinese complain they cannot obtain a bank mortgage for a house and cannot easily sell it on the secondary market? A: China should liberalise the right to sell and rent homes. Currently, those who buy homes from their work units may have to wait for five years to sell them. But they may . . . want to sell [them] and use the money to buy another home.
Banks may be willing to lend for only five years if there is no significant downpayment or financial market to offload mortgages.
Housing subsidies need to be monetised and the cost of homes must come down.
There are the issues of transparency and equity involved and the government fears that it would look bad for people to acquire homes at a preferential price and then sell them immediately. But housing reform stimulates growth greatly - and has no budgetary impact.
Unlike other measures, it does not cost the government anything. It has a ripple effect, more than investment in infrastructure. It would transform personal savings into consumption and investment.
The current savings rate, of 40 per cent, is too high at this stage in China's development because people do not have enough opportunities to invest money or to increase consumption in areas such as housing-related expenditures.