Transcript of a Teleconference Call on China, With Steve Dunaway, Mission Chief to China, Asia and Pacific Department, IMF

September 12, 2005

Washington, D.C.
September 12, 2005

MS. BHATT: Good afternoon everyone. I'm Gita Bhatt, Senior Press Officer with the IMF, and I want to welcome all of you to this conference call by Steven Dunaway, who is the Deputy Director of Asia and Pacific Department of the IMF and the Mission Chief for China.

Mr. Dunaway is here to answer any questions you may have regarding the Public Information Notice related to the conclusion of the 2005 Article IV publication with the People's Republic of China, which I hope you've all received and had a chance to read.

Before we begin, let me briefly go over the ground rules. This is an on-the-record conference call. Mr. Dunaway's remarks as well as the PIN are embargoed until 5:00 p.m., Washington, D.C. time, which is 2100 GMT.

Mr. Dunaway has about 20 minutes, and he'll take your questions right away.

QUESTION: Thank you very much, Mr. Dunaway. Just a quick question. You mentioned in the report here that some protectionist sentiment and trading partners and some of China's trading partners have tamped down growth a little bit. I assume you're talking part of that is the textile safeguard. Could you speak more specifically of how the safeguards from Europe and the U.S. have affected China?

MR. DUNAWAY: Well, at this point, we haven't done any specific analysis of how much of an impact some of the safeguards would have. That's extremely difficult to do because you're dealing with a counterfactual in terms of how much growth would have been if those safeguards weren't put in place. What we were talking about was in terms of the risk to Chinese growth going forward; that the possibility of protectionist pressures and particularly of some of these safeguards might eat into the rate of increase in exports. But we don't have specific estimates on how much effect it may be having.

QUESTION: Could you just summarize what your view is of the Chinese economy now? From this report, I don't get a sense of just like the overall. Like could you just summarize. Are you worried about inflation? How does growth look? What's the outlook?

MR. DUNAWAY: At this point, you know, the overall economy looks very strong and looks very good. Growth is running at a nine to nine and half percent rate and our forecast for the year is nine, but we'd probably mark it up depending upon the third quarter numbers in particular, which continue to look pretty strong.

Inflation also looks good. The August numbers that came out today showed a year-on-year rate of increase of only about one and a quarter percent. So overall, the economy looks good. But, you know, there's a few potential risks there, the key one being with regard to investment. The government was quite successful in slowing down the rate of increase in investment last year, but there's still a lot of liquidity in the banking system so that credit growth could pick up and investment could start to kick up again.

So we see that as a potential risk in the situation, although, as I've said, overall the situation looks very good right now.

QUESTION: Have they achieved then a soft landing? Is this what a soft landing looks like or do they have more to do?

MR. DUNAWAY: Well, if you want to characterize nine percent plus growth as a landing, yes, I guess you could call it a soft landing. We just sound a cautious note in terms of looking at the banking system in particular and seeing how much liquidity is available to the banks and how that could fund another spurt of growth in lending. And so that's why we cautioned the Central Bank on continuing to drain money out of the banking system so that they basically take away the fuel that could fire another rise in credit growth.

QUESTION: I have some questions. First of all, you say that the government has curbed some of the over investment. However, in the table, in the last page of the PIN, we see that direct investment is going up this year, according to your projections.

So I would like to know how you reach this conclusion and why do you think the over investment is under control? There is also another thing that is not very clear for me that you say that the recent steps taken by China towards more flexible exchange rates are welcomed but they're not enough. And you don't mention the need for a revaluation, but more steps to become more flexibility. So I'd like to know which of these steps.

And also you mentioned that some of the data and statistics of China are not very transparent, so I'd like you to elaborate a little bit more on that. You mentioned only GDP numbers. But I would like to know which are the main data that you think China is lacking comparing to other economies. Thank you.

MR. DUNAWAY: Okay. Well, our investment—it's a combination of two things. One is that the rate of growth investment has slowed down relative to last year. The other is in terms of the composition of investment; that it has moved away from the sectors of the economy where there looked to be last year significant over capacity developing, you know, particular in terms of metals, in terms of the construction industry, in real estate construction. The steps had been taken to slow those things.

And investment has shifted more toward areas of the economy where bottlenecks were developing, you know, particularly in electricity generation and also in transportation. So a combination of slower growth plus a shift in the composition of investment we see as a result of the government policy and a shift towards a more sustainable situation.

On the exchange rate, the point that we've stressed for a very long time is that greater flexibility in the rate, in the exchange rate, is in China's best interest, not a revaluation of the rate. And so what we have said, and the Managing Director has commented, is that we welcome the change in the regime and that we encourage the authorities to fully utilize the flexibility in the rate, because it will enhance their ability to conduct monetary policy domestically as well as it will also help to insulate the economy from economic shocks.

Your third question on data. The national income accounts is one key area, where there's some significant deficiencies in the data, and the authorities are working to address them; in particular if you look at, for example, the alternative measures of GDP, if you look at it from the production side versus from the expenditure side, you get some significant differences in terms of what the rates of growth and GDP have been.

For example, last year, GDP estimated from the expenditure side was roughly two percentage points of growth higher than from the production side. And part of this is probably a remnant of the reporting systems that existed previously under the centrally planned economy, where the emphasis was more on manufacturing and heavy industry and the coverage of what the Chinese refer to as the tertiary or service industries is not as good as it could be. And these are areas that have seen a lot of growth in the Chinese economy.

So the Chinese are in the process of conducting a census of business in China to get an idea of exactly what the production is in the various sectors of the economy. And out of that, they'll be able to generate more accurate national income accounts. And you'll get more—closer measurement from the different aspects—from production or from the expenditure side in terms of GDP.

It's not a problem unique to China. A lot of both developed and developing countries have somewhat similar problems in their accounts, and periodically there is a need to update the methods that are used to estimate the accounts.

The balance of payments accounts are probably another area where some improvement would be useful, particularly with respect to the capital side of the balance of payments. And there, again, it's a problem a lot of countries have, where it's very difficult at times to estimate all of the capital inflows and the capital outflows.

QUESTION: Just one follow up. Is there any measure towards flexibility that China—that was suggested by the IMF to China or that a step that China could do on the short term to increase the flexibility of the rates or the exchange rate?

MR. DUNAWAY: Well, it's a managed floating rate now, so it all depends on how they manage the float.

QUESTION: My question is regarding whether or not China were to reassess their exchange rate. And you say in the report that they have a responsibility of a larger nation to make sure there are no imbalances. Aside from the responsibility globally, what else would China get out of such a thing? Are there any other benefits aside from it's good neighborly thing to do?

MR. DUNAWAY: We've always argued that it was China's own best interest to move to a more flexible exchange rate, the key reasons being in terms of independence of monetary policy domestically; that they would have better control over the domestic money supply with a more flexible exchange rate.

And also the flexibility in the exchange rate will provide some insulation to the economy to changes—to economic shocks that may occur, particularly external shocks. If the rate is—in particular under the previous regime, where the rate was essentially fixed against the U.S. dollar, then the adjustment has to come in terms of domestic prices to a potential external shock. Whereas, with a more flexible exchange rate, the exchange rate—movements in the exchange rate as well can cushion some of the effects.

So at the end of the day, it's in China's best interest to move to a more flexible rate and at the same time, it has the secondary benefit of also contributing to improving the imbalances globally.

QUESTION: It appears from the way the PIN is written that there's a split in the Board as to how fast China should be moving to a more flexible exchange rate. What's the staff's view? Is it some Directors supported a cautious approach and others thought they should move more quickly? Does the IMF staff think that China should be moving more quickly to a flexible exchange rate?

MR. DUNAWAY: It's a tough call in terms of trying to pick the speed. It's a combination of, yes, of economics and political economy at the same time. As we've said, from a strict economic point of view, the more flexible the exchange rate, probably the greater benefit. But at the same time, and more from a political economy point of view, is you have to gauge the ability of the economy to deal with the change in the exchange rate arrangement itself and to accept it.

So you've got those two factors trading off. And so I guess in the end, it's, as I've said, it's very difficult to say, you know, precisely what the speed at which you can reasonably expect the exchange rate to move.

Historically, during the reform period, the way that the Chinese have approached reforms has been to move in small steps and preparing the way before they moved to gauge the impact. And as they gained understanding in terms of what the effects were, then they had a tendency to move more broadly. So that may be part of the strategy in the way that they're moving on the exchange rate now.

QUESTION: You're calling for the review for that the IMF Directors noted that effectiveness of monetary policy would be enhanced by growing the People's Bank of China more discretion of interest rate policy. Can you tell us what you mean by more discretion? Are you calling for a move here to operational independence?

MR. DUNAWAY: Well, I'm not sure how you define operational independence, but basically at present changes in interest rates need approval from the State Council. So what we were suggesting was that as the economy has developed, that at least as an interim step perhaps there may be a range of movement in interest rates which could be done at the discretion of the PBC without having to go and get approval from the State Council. So giving the PBC more flexibility in its ability to use various types of monetary policy instruments.


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