The adjustment of China’s growth strategy and macroeconomic

stabilityYu 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

- 50000

0

50000

100000

150000

200000

250000

1982

1984

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1998

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2006

In U

SD M

illi

ons

cur rent account FDI

200 bil + 60 bil

The increase in foreign exchange reservers

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2000

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120001990

1991

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200 bil a year

Rewards for being a debtor

Punishment for being a creditor:

China’s current account surplus and investment income deficit

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-20, 000

0

20, 000

40, 000

60, 000

80, 000

100, 000

120, 000

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160, 000

180, 000

1999 2000 2001 2002 2003 2004 2005

Current accountI nvestment i ncome

Except for 2005, over the past 25 years, investment income balance has always been in deficit

Due to appreciation expectations

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

i

s

0

ca

投资收入

Trade balance

Current account

saving

investment

I

II

III

IV

V

VI

Net worth

Investment income

Six stages of economic development: where is China

Stage China is inWith 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?)

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40. 0

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1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998

Year

Rati

o of

Mon

ey t

o GD

P (%

)

Chi na P. R. I ndi a I ndoni si aBrazi l Pol and Uni ted StatesJ apan Korea Germany

M2-GDP ratios of different countries

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

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央行票据%在商业银行资产中的占比（ ）

Central bank bills/total assets rate is increasing steadily

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 Lending 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 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