Transcript of a Conference Call on the 2012 Article IV Consultations with China

July 24, 2012

With Markus Rodlauer, Deputy Director, Asia and Pacific Department
Steven Barnett, Deputy Division Chief, Asia and Pacific Department
Jeremy Mark, Deputy Division Chief, External Relations Department
Washington, DC
Wednesday, July 24, 2012

MR. MARK: Good evening and good morning. Thank you very much for joining us. My name is Jeremy Mark, Deputy Chief of Public Affairs with the IMF External Relations Department. Welcome to this evening, this morning’s teleconference on the Article IV Staff Report on China. Before we begin, I’d just like to remind you of the ground rules we have: the conference call is on the record. However, it is embargoed, along with all the reports that you have downloaded and read. It is embargoed until 9pm Washington time, that’s roughly 57 minutes from now. That’s 9am Wednesday morning in Beijing. Having set the ground rules, let me proceed to tonight’s speaker.

Joining me tonight, we have two IMF officials. First, Markus Rodlauer, Deputy Director of the IMF Asia and Pacific Department. Markus is also Chief of the IMF Mission to China. Also joining us tonight is Steven Barnett, who is the incoming Division Chief for China, in our Asia and Pacific Department. Now before we take your questions, I’d like to ask Markus to take a few minutes to offer an overview of the IMF Article IV Report on China, and then we’ll go to your questions. Markus?

MR. RODLAUER: Thank you Jeremy and thank you for this introduction. Let me start by saying to all of you, it’s a great pleasure for us to be here and for you to be with us to show interest in our consultation report. We look forward to your questions and hope that we can answer them.

So really, there were two broad themes, challenges that we explored during this year’s annual consultation between China and the IMF. First, the long term need to continue transforming the economy, and second, the more immediate, short term challenge of managing the slowdown, the cyclical position of China.

Regarding the long term, you all have heard the theme of rebalancing the engines of growth: away from exports and investment, toward domestic consumption. We have seen recently significant progress with external rebalancing, perhaps most clearly in the sharp reduction of current accounts surplus. But this was accomplished in part by a further rise in what was already a very high level of domestic investment, and therefore internal rebalancing is now a key priority. And in simple terms, it means moving away from investment towards consumption as a key driver of growth. Transforming the economy has also other dimensions, such as, for example, building a monetary and financial system that relies more on price signals that is able to allocate capital more efficiently and where the risks are well-managed. And perhaps above all, transforming the economy means ensuring that the benefits of growth are distributed widely and equitably. That is, among the regions, between all rural and urban areas and among different income levels.

Let me now turn to the more immediate, short term challenge of managing the slowdown, ensuring a soft landing, so to speak, from the large stimulus of 2009, 2010. In the middle of a global slowdown, and the large uncertainties about how the external environment will evolve in the period ahead. How do we assess the near-term, cyclical position of this economy? And the government’s response? W have now seen about a year and a half, six quarters of slowing growth in China -- a slowdown which was started initially, quite deliberately, and forcefully by government policy. More recently, this deceleration of domestic activity has been compounded and exacerbated by the renewed deterioration in the global economy mainly from the crisis in Europe.

In response, the government in recent months has shifted the policy stance across a wide range of policies towards supporting growth. However, these measures have been calibrated so far mainly to remove the previous restrictive bias and not to engage in a broad new stimulus. For example, public investment has been declining quite significantly into early this year. We had seen negative year-on-year growth lately of investment, of public investment. The government has now accelerated the implementation of already approved projects but we have not seen a major addition of new projects like we saw in the large additional spending stimulus in 2009, 2010. At the same time, the authorities have also told us that in light of the large uncertainties in the world and the risk of intensifying strains and crisis in Europe, they, they are prepared to do more and significantly more in the face of a large external shock. In other words, the authorities have taken the foot off the brakes, but they have not yet stepped on the accelerator in a major way. But they are ready to do so and they have room to do so if needed.

The latest incoming data seem consistent with growth settling down at about 8 per cent on average this year without the need for major additional stimulus; however, there is a degree of uncertainty about this data and we will need to monitor incoming data very carefully in the coming weeks and months. And the authorities who typically react quickly to changing circumstances may well see some further deterioration in the weeks and months ahead and then respond with additional measures.

Now, I expect you also will be interested in our assessment of the exchange rate, the renminbi. Left me first clarify that our assessment of the exchange rate draws on the range of inputs including recent developments in the current account as said before, it has come down a lot, the surplus from over 10 per cent of GDP in 2007 to less than 3 per cent of GDP last year, the slowing pace of reserved accumulation, the appreciation of the renminbi that has already happened in real effective terms, which means relative to a basket of currencies – not just vis-à-vis the dollar- there is appreciation in recent years, and last but not least, a range of quantitative models and estimates that we have in the fund for assessing the current account and the exchange rate against fundamentals and economic policies. Taking all these inputs together, we have reached the conclusion that the degree of under-valuation of the renminbi has come down significantly and that the renminbi is moderately undervalued against a broad basket of currencies. You will note that this is a significant change from last year’s consultation, 2011 Staff Report when we had assessed the exchange rate as substantially below the level consistent with medium term fundamentals.

As this being said, we are also clear in our minds from our estimates and work that some further appreciation is appropriate going forward over time and in tandem together with other policies to support rebalancing. And this takes us full circle towards what I said at the beginning, transforming the economy. The exchange rate issue is obviously of keen interest to many and it is an important piece of the whole policy framework. But I want to highlight that it is just one part of the package of reforms needed to rebalance the economy. As we have emphasized before, our analysis indicates that currency appreciation alone would yield limited benefits for China and the world. Instead, a broad package of reforms is needed to achieve quality growth that relies less on export and investment and more on domestic consumption. The key elements of these reforms are: opening up the service sector; raising the cost of capital so that investment becomes relatively less profitable than it is now, allowing for continued gradual appreciation of the renminbi; improving the social security system, and reforming the financial sector. Implementing this package would substantially boost living standards in China and contribute significantly to strong, sustained, and balanced global growth. This is generally what I wanted say at the beginning, so I hand it over to you.

MR. MARK: Very good. I think what we can do now is turn to the questions.

QUESTIONER: I just want to talk you about the moderately undervalued. In the report, it also says that Chinese think that it is at most, slightly undervalued. What does that mean in actual terms -- what does moderate mean as a range from, you know, the 2 per cent or 5 per cent or however you look at it and what about it is like -- what does that mean?

MR. RODLAUER: Thank you, Bob. Thanks for being there and also thanks for this very good question. You know, we have deliberately refrained in the report from citing quantitative estimates because numbers tend to get a life of their own. There is a range of estimates and you will see some of those estimates in the forthcoming External Sector Report, which will be issued shortly. However, as you say, there is a difference in assessment here. We feel it is moderately undervalued, which means there is a non-trivial way further to go.

The authorities themselves are more inclined to see the renminbi currently at close to equilibrium. They look at the market situation where there is two-way pressure. In fact -- as you know—the exchange market has recently seen a slight depreciation of the renminbi against the US dollar. Nevertheless, we are quite confident in our judgment that without further reforms and adjustments, that is with the current level of the exchange rate and with all other policies as they are currently set, it will be very likely that the current account surplus would go back up again, certainly not to the levels as it was before but it would go up from where it is now. And in order to prevent that, to maintain no more than a small current account surplus, to maintain two-way pressure in the exchange market, our judgment is that continued gradual appreciation will be necessary over the coming years.

QUESTIONER: I think in your report, tracking the RMB stopped at around April and beginning at around April, the currency in China depreciated against the dollar, I wondered what you thought of the current direction, which it seems to be weakening the currency as opposed to strengthening the currency?

MR. RODLAUER: Well, three things about this one. First, we don’t follow day to day exchange rates that much, that is influenced by many factors--as you know, markets behave in certain ways. Our job is more to look at the medium term fundamentals, and that’s where we look at. So we don’t really feel that too much can be said about the medium-term direction just by looking at daily numbers. On top of that, we are of course in a situation where the dollar has been on an upward trend relative to currencies like the euro. So if you look at this in effective terms comparing the renminbi against the basket of relevant currencies, the picture is somewhat different and there has been significant appreciation. Certainly over the past 12 months, we have seen 8 per cent real effective appreciation. So that’s the trend, and the direction I think is clear, and will and should continue. I don’t know Steve whether you want to add something on this one, but I think, that’s how we see it.

MR. BARNETT: I think it is key to look at the medium term context. Our assessment of moderately undervalued really refers to the medium term situation where we see the current account surplus returning to the 4 to 4 -1/2 percent of GDP range. The recent developments in the foreign currency market do no change our assessment in this regard.

MR. RODLAUER: And when we say moderately undervalued, we don’t mean that the right policy would be to immediately fully appreciate the currency to where we think it should be over the medium term. As I have said, this is something that needs to come as a package, overtime, gradually, supported and engineered by structural and macroeconomic policy.

QUESTIONER: My question is about the renminbi also. You mentioned that renminbi is still moderately undervalued. Tell me like in real effective terms and let me know in effective terms, how many per cent do you think is undervalued so far?

MR. RODLAUER: You are quite right. When we talk about undervaluation, we are talking about effective undervaluation, which means not just against one currency like the dollar but against a basket of relevant currencies, which of course includes the Euro, the Yen, and their important trading partners’ currencies. So it’s the effective terms. Second, you were right in saying it’s the real effective value that counts. So that’s a relative comparison of currencies and their purchasing power and depending on the inflation of one country to another, that also plays a role, but as I have said, we are not in the business of quantifying precisely the exact percentage of under evaluation. That is something that we do not feel very confident in doing. We have our estimates, we have our ranges, but these are all tentative, and we would like to refrain in our bilateral consultation from putting out these numbers because as I’ve said, these numbers tend to get a life of their own, and this is not particularly useful to do that. The key point is that in our judgement the renminbi is moderately undervalued, which is very different from the substantially undervalued, and this should suffice in order to give policy direction.

QUESTIONER: I have one more question. It is about the economy… the size of the stimulus… So what is the definition in the fiscal side and the monetary policy side to support the economy?

MR. RODLAUER: Thank you for asking this question also. On the technical question, if I understand you correctly, of what kind of policy the government right now should implement in order to a safeguard recovery but also to preserve what has been done in terms of unwinding the previous stimulus. That’s exactly the balance I think that they are looking for. The authorities have calibrated their policy to the incoming data to see how much of support is needed, how much should be given to ease the economy to a soft landing, but at the same time not overdo it, because a lot of work has been done and it’s not painless. It’s painful to remove the adverse effects of the very large stimulus of the past, to slow down the booming real estate sector, slow down the very high rate of credit growth, slow down investment to a more sustainable path. That has been difficult. So you don’t want to throw all of these out of the window and restart the engine full steam. So they have to be very careful how they have shifted and so far, they have done well. At this point, we feel that the policy is well calibrated to what the situation is, but as I have said, the situation is evolving, certainly on the external sector—we get news, you get news everyday from Europe, currently they are not that encouraging and the situation is also evolving on the domestic side. Every week China is getting new incoming data. It is a rush of data which are being published every week in China and they need to be looked at continually and the policies may need to be adjusted as we go along.

QUESTIONER: What is China’s official response to the Staff Report? Last year, they said that IMF projection of currency count suffers based on the shaky mathematics. And this year, let’s just say that John Carl said that your estimate on the currency being moderately undervalued is not consistent with reality. His words seems fairly harsh—this seems fairly harsh to push back, and I am wondering if the Fund was used to getting this kind of wording from its member.

MR. RODLAUER: First of all I am not here to speculate and comment on the authorities’ official account. I think they stay on their own, they say exactly what they mean. I think it is quite normal that in consultations like this, we do have different views on certain issues. We do not see eye to eye on everything. We have extremely productive discussions that are not only courteous and friendly, but they are also very engaged and deep. We agree on many things. We agree on the broad direction of reforms. We agree on the cyclical position of the economy, on the broad policy context that is in place right now, but we disagree on the exchange rate and that is very normal and happens all the time.

MR. MARK: We’re going to give everybody a few more moments, in case someone does think of another question. Steve, did you want to add something?

MR. BARNETT: I think I can give a bit more flavour on the question of the differences in the current account projection. I think it is important to understand that we are looking at the medium term. There’s a lot of assumptions that go into these projections, and from our point of view, we are making an assumption that over the medium term the global output gap is closed, that means all of the advanced economies close their output gaps. The authorities have different views there. We are making assumption about what’s happening to global prices and we are also making assumptions about the path of the real effective exchange rate, using the IMF convention of constant real effective exchange rate. So, our projection is a product of all of these assumptions. The disagreement on the forecast reflects a few disagreements about some of these assumptions as well. We spell out in the staff report the specific assumptions we are making to arrive at our projection of the current account surplus.

QUESTIONER: Since everyone else just asked, I will ask another question. On a different issue, you talked about housing, the ability of the authority to inflate the housing level. I recall, you know, many debates in the US (inaudible) possible to deflate housing bubbles so was my fair policy anyway, and so the idea was to kind of let them come and go. Is there anything one can learn globally from the way China has managed this housing problem? Anything that you would say significant in the way they manage this and anything applicable to other countries?

MR. RODLAUER: Great question. There are two things I want to say, first about the housing bubble and the deflation, and while I speak to these points I’ll be thinking whether there are any lessons for the global economy, I am not so sure. When we talk about deflating the housing boom in China, my understanding is that this was not primarily the task of monetary policy; the goal of monetary is more macro, to steer the whole economy, not specific sectors As you know there are many more instruments available to China’s authorities in doing that; they can be has been -- in particular on the housing side -- much more direct with other instruments they have, like the various ratios, such as loan to value ratios, more direct incentives or direct sort of messages to the market, which tend to work in China. Even though we hope that they would move more towards price oriented measures, this is just the way the economy works there. So they have had these tools, and have used them, which is one of the reasons probably why they were quite effective in doing it.

More fundamentally, however, those will not be the kind of tools that will prevent housing problems in the future. We have seen now three housing bubbles in China over the last decade, which indicates that this economy is prone to this sort of housing bubbles and it would need much more fundamental measures to remove, to prevent housing bubbles in China, which have to do as you all know with the way how the household save in China, there is no other outlet (besides bank deposits) than real estate. There is a whole range of issues that make the economy inclined towards boom and bust cycles in housing, which need to be addressed more fundamentally. Now, whether there are lessons for the global economy, I am not so sure, Bob. Given the structural differences of these economies, I wouldn’t immediately think that there is much that I can see we could learn but it is a good question that I may have to think about going forward.

MR. MARK: Okay well, we are basically at 8:30 PM and 8:30 AM so why don’t we just say that we will end it here, and our embargo runs for another 30 minutes until 9 PM, 9 AM and if you have any follow up questions you can come back to us directly through IMF Media Relations and thank you for joining us this evening, this morning and we will talk to you again in a year.

MR. RODLAUER: Thank you so much all of you who were there.



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