Transcript of a Teleconference Call on China, With Steven Dunaway, IMF Mission Chief to China

August 25, 2004

With Steven Dunaway, IMF Mission Chief to China
Wednesday, August 25, 2004
Washington, D.C.

MR. MARK: Good afternoon. My name is Jeremy Mark. I'm with the IMF External Relations Department, and I'm just going to be moderating today's teleconference. As you know, today's teleconference is on the Public Information Notice related to the conclusion of the 2004 Article IV consultation with the People's Republic of China.

With me today we have Steven Dunaway, Deputy Director in the IMF Asia-Pacific Department and China mission chief, who will be taking your questions. This teleconference, as is the case with the PIN, is embargoed until 6:00 p.m. tonight. This is a teleconference on the contents of the PIN and our discussions with China during the Article IV, so I will ask you to please refrain from raising questions on other issues. Before we get started, I'd just like to ask you to identify yourselves and your news organizations before you ask your question. Can we please proceed directly to the questions now?

QUESTIONER: I have a couple of questions. One is a minor technical one. How recent is this data in terms of how fresh are the forecasts—or the data that you used to compile the forecasts?

And then the other questions I have are: Are you still of the opinion that there's no clear evidence that the Chinese currency is undervalued? That was something that you expressed in November when the 2003 Article IV came out.

You also said in that report that China should take more advantage of the current conditions to move towards greater flexibility. Are you seeing more urgency now?

MR. DUNAWAY: On your first question, the answer is that the discussion of the staff report was held at the end of July, and it was based on data through June. So the forecasts are as current as we have right now for China.

Now, on your second question with regard to our view on the value of the renminbi, it's basically the same. We still find it very difficult to come up with evidence that would suggest that there's a substantial undervaluation of the currency. We think that, as we have for quite a while now—since 1999 we've offered advice to the Chinese authorities that they should move toward greater flexibility on the exchange rate. And we think that particularly with some signs that capital inflows-the very large capital inflows that they experienced over the past year, year and a half-seem to be abating some, the conditions may become very favorable to begin this process of a gradual increase in the flexibility in the exchange rate, which we firmly believe is in the best interest of China. And the authorities themselves see it also as being in their best interest. It's been more a question of the timing of the first move.

QUESTIONER: Everyone says sooner rather than later. When is it, you know, becoming later? When is it time? Are you saying, now, today, this week, this year? It seems that this is the same message over and over, and at a certain point it seems that the conditions are going to be past prime.

MR. DUNAWAY: Yes, that's one of the points that we've emphasized to the authorities. If we look at the experience of other countries with fixed rates, you can divide them up into a number of cases where they did wait too long and the conditions under which they were forced to make adjustments in the pegs were not ideal; whereas, there are other countries who have successfully moved at times that were very favorable. And in general, what experience shows is that those favorable conditions are when you have relative strength in the balance of payments, which is what China has now.

QUESTIONER: My question is on the part about where the Board was talking about the need for further monetary policy tightening. There seems to be a split in the Board. Can you give some more information about what the differing opinions were and how split the Board was on whether they need more monetary policy tightening sooner, or soon in the near term?

MR. DUNAWAY: Well, I guess it's not just the Fund's Executive Board that has mixed views on this. This is a big debate within China itself right now in terms of how much the economy has slowed down and how tight credit conditions are at present. It's part of the problem. The data that have come out give you a mixed picture. Some of it seems to suggest that credit growth is slowing down, that investment is slowing down. The latest batch of data tend to go the other way, that in particular investment growth through July was a bit stronger than it had been through June.

So it's a question of approach, of either waiting and seeing whether the measures that have been taken so far are sufficient to slow the economy down, or whether additional actions need to be taken.

Now, from the IMF staff's perspective, the way that we looked at it is that there still tends to be a substantial amount of excess liquidity in the banking system and that we see that the administrative measures taken have played a major part in slowing the growth of credit.

We also know that there's a tendency over time for the effectiveness of those administrative measures to dissipate, either because they begin to be relaxed, exceptions are made, or people find ways around the controls. So our concern is more focused on this excess liquidity in the banking system, and that if the administrative controls become less effective, then credit growth could start to take off again.

So we saw more of a pressing need for some additional monetary tightening to take that excess liquidity out of the system. Sooner or later, it would need to be taken out. We thought that conditions were such that sooner would probably be better to ensure that there was a nice slowdown in the economy.

QUESTIONER: I see from the PIN there's very careful language used on the flexibility of the yuan, and I wanted to find out generally what the overall thinking is here—or is the Board also split on this one?—when you speak of many Directors considered that it would be advantageous for China to make an initial move toward greater exchange rate flexibility without undue delay, and then with some Directors preferring that this move be made soon. Am I sensing that there is a difference here in those two? They sound pretty much the same to me.

The other question I have is: Does the IMF have a sense of whether China is planning to revalue the yuan or actually widen its trading band?

MR. DUNAWAY: Let me answer your second question first, and there the answer is simple. It is I can't really speculate on what they're going to do. It's our position and our responsibility to make policy recommendations on what we think they should do, and that's, in essence, what we've done. As I've said before, I think there's broad agreement between both the IMF and the Chinese authorities in terms of a movement to greater exchange rate flexibility is in China's best interests. Again, the question is when.

Now, as regards to the Board itself, there's also the general agreement that the best timing is a decision that's left up to the authorities, the Chinese authorities themselves. But that being said, there are differences in views, in terms of the necessary conditions or the appropriate conditions for making a move, with some directors feeling that, well, you know, there was time to consider all of the potential ramifications in greater detail and to worry about, as I said, sequencing of other actions.

Other Directors are looking at it in terms of conditions were favorable to potentially begin this process of increased exchange rate flexibility in the near term.

It's not that you try to pick the timing of a move in the exchange rate. It's nothing terribly precise. At the end of the day, it's a judgment that's based off of trying to factor in a number of different things, and so that I think explains why there's this difference in views.

QUESTIONER: You mentioned a little bit about the banking system strengthening. I'd like to know if the IMF thinks that the strengthening is a precondition for more flexibility in the exchange rate, and what's your evaluation about the banking system in China today?

MR. DUNAWAY: No, we don't feel that strengthening the banking system is a precondition to increasing the flexibility in the exchange rate; that if you look at the exposures in the banking system, foreign currency exposures, it's not a great impact.

Also, given the capital controls, there's not a substantial threat to the banking system of substantial movements of funds out of Chinese banks into alternative investments. So we don't see strengthening the banking system as being a precondition to greater exchange rate flexibility.

Of course, strengthening the banking system is extremely important from China's own perspective; in terms of part of the concerns about overinvestment in the economy stem from the fact that the banking system doesn't do a terribly good job of intermediating savings in China, that they're not lending necessarily to the most productive projects that have economic return for China.

And so from that perspective, there's a lot of domestic reasons why you need to strengthen the banking system. But then, eventually over time, it also becomes important, as you open up the capital account more.

Now, over the past year, there's been some increased progress, increased emphasis on reforms in the banking system, which are characterized by the recapitalization of two of the large state-owned banks last December, and the continuing pressure on those two banks with rigid, rigid deadlines and timetables set up for them to clean up their operations and to move towards a more modern and efficient banking system.

At the same time, there's also efforts in other parts of the banking system to improve both the supervision, but also the operations of the banks themselves.

QUESTIONER: But on your current evaluation of the banking system in the country, is it solvent?

MR. DUNAWAY: The balance sheet problems, as reflected in the very large, nonperforming loan ratios for the banking system as a whole: no. Those problems aren't fully solved, and more efforts are going to have to be made and additional capital may need to be put in by the government. There is a requirement that all of the banking institutions by the end of 2006 need to meet Basel capital requirements. So there still are a lot of fundamental problems in the system, but there are efforts to try to correct those problems.

QUESTIONER: you mentioned earlier that the data you have, I believe you said it went to June. In the discussion of the economy's growth, you said growth would be around 9 percent this year, but should move to a more sustainable pace of 7.5 percent next year. Is that 7.5 percent a new forecast for the IMF? Or have you been calling for that all along?

MR. DUNAWAY: We've been in that range for a while, between 7 to 8 percent, so 7.5 percent forecast for 2005 is roughly in line with what we've previously forecast.

QUESTIONER: Just a question on this possibility of a soft landing versus hard landing. I see that there is still some concern that a soft landing in the economy is not assured. Could you talk about that a little bit more?

MR. DUNAWAY: As I said, the numbers that we see, the economic data we see, is kind of a mixed bag. I guess two series jump out at us that reflects some concerns. The investment numbers still remain very strong, and some suggestion that in July perhaps the investment started to pick up a little bit with the rate of increase rising.

Another concern is with the CPI numbers, that on a year-on-year basis the rate is 5.3 percent, and then if you look at it on a month-to-month, on a seasonally adjusted basis, inflation is running at roughly around a 6-percent rate over the past 3 or 4 months. Now, a lot of this is confined to food and to some energy categories, but there's always a concern that this could spill over into other components. So those are two of the things that jump out of the data.

We, also, we aren't entirely clear on how much credit growth has slowed down. It appears to have slowed significantly, but part of the problem in interpreting the data stems from the fact that you've had write-downs of bad loans from the banks. So you're not quite sure exactly how much of it is either a slowdown in credit growth or just the fact that the banks are doing more to clean up their balance sheets.

The other thing that kind of struck us as part of the slowdown in the growth of broad money, M2, is attributable to slower deposit growth, which is some suggestion that money is going someplace other than into the banking system. And there are a lot of anecdotal stories about alternative credit markets and that those markets are helping to fund some of the continuing relatively strong levels of investment.

So, as I said, it's a mixed picture. We look at the ratio of required to actual reserves, and we see that there's a significant amount—roughly, 3, 3.5 percent of excess reserves in the banking system which is money that could be lent out. So it tends to make us a bit cautious about exactly how much of a slowdown has occurred up to now and whether or not some additional tightening of monetary policy in particular may be needed.

QUESTIONER: The question I have is about the debate about whether Beijing should drop administrative measures; i.e., some plea ordering banks not to lend to certain industries in favor of more market-oriented ones like raising interest rates. But the argument against an interest rate hike is that it might hurt state companies that rely heavily on bank loans. It would be interesting to hear what your view is on this one.

MR. DUNAWAY: At this point, it's still a pragmatic judgment. First, you can make a distinction between two types of administrative measures. There's one type of administrative measures which are basically prudential and supervisory in the banking system. So there may be changes in certain supervisory guidelines.

For example, some of the things that have been done is that minimum down payments or the minimum amount of funds that have to be invested by a developer in, for example, a real estate project, that those things have been raised. And this is being done for prudential reasons. Or the China Bank Regulatory Commission has provided some instructions to the banks to be careful in the way that they evaluate loans and the ability of loans to be repaid. That's very similar to what's done in other countries. So you have those types of supervisory administrative actions which are very normal and part of a market-driven situation.

You, also have in the context of China the more traditional type of administrative measures that have proven to be relatively effective; they have been using environmental policy and land-use policies to control investment. And over time those things hopefully will be phased out.

But part of the problem now, as I said before, is there's a great difficulty in the intermediation of savings and the banking system. In part, that's related to the fact that you have ceilings on lending rates. So one of the things that could help in creating a more market-oriented financial market would be to remove those ceilings on the lending rates. So over time you can see full development in the financial system which would obviate the need for the more traditional administrative measures that Chinese have used in the past.

QUESTIONER: What, if any, is economic impact of the recent report that China is unable to feed its people and has to import increasing amounts of food?

MR. DUNAWAY: I do not interpret that as China being unable to feed its people. There's a number of industrial countries that have net deficits on agriculture, and I don't think that you would go so far as to say they were incapable of feeding their people. Part of it is a reflection of the movement into the WTO and the opening up of China's agricultural markets, changes in taste in China, as well, which lead to increased imports of food products. But I don't see it as a "threat" to China's ability to feed itself.

QUESTIONER: I know we've spoken about the soft landing and so on, but overall do you think the government has brought everything under control?

MR. DUNAWAY: Well, they've done a lot to bring about a soft landing. If you were going to try to hold me down and say what the percentage of the chance of a soft landing versus a not soft landing, well, as long as the administrative measures taken continue to remain effective, we would see China evolving in line with the basic forecast that we have—the growth over the course of the second half of this year would slow down to the range of about 7.5 to 8 percent, and then that would give us about 7.5-percent growth for the year in 2005. But as I say, that's based on of the effectiveness of the current set of measures continuing or continuing to have the same impact.

Now, to quote a former colleague, Michael Mussa, who was fond of using the idea of insurance, we thought that maybe a little insurance in the form of draining a little bit more of the liquidity out of the banking system was not a bad idea and that that would help to ensure a soft landing of the economy.

QUESTIONER: But not enough yet to start relaxing controls on credit and investment?

MR. DUNAWAY: No, I think it would be a mistake if there were a relaxing of the controls on investment. One of the things that we've done is we've gone back, and we've looked at previous cycles in China. And one of the lessons that comes out of the last cycle in the mid-'90s was that the duration of that cycle was relatively long, and there was a lot of upward and downward movement. Part of the problem was that at the points where controls, in particular, were starting to have a binding effect, doing what they were supposed to do, there was some backing off of the controls. So it kind of dragged the whole cycle out. So at this point we would not want to see a repeat of that, that the controls stay in place until they've done the job that they were intended to do.

MR. MARK: We'd like to thank you all very much for joining us this afternoon, and I would like to reiterate that this teleconference and the PIN are embargoed until 6 p.m. tonight. Thank you very much.


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