Transcript of Conference Call on China's Article IV Staff Report
July 29, 2010Washington, D.C.
Thursday, July 29, 2010
MS. UTSUNOMIYA: Good morning and good evening to some of you in Asia. This is Keiko Utsunomiya, a press officer for the IMF External Relations Department. I'm here with Mr. Nigel Chalk China Mission Chief. He's going to give -- say a few words about the Staff Report that will be released in about an hour, and then we will take questions. This is on-the-record conference, and both Staff Reportand this press conference is embargoed until 9:00 a.m., Washington time, which is about 55 minutes from now.
Before asking questions, please state your name and affiliation. Nigel?
MR. CHALK: Thank you, Keiko. So all of you will have seen the Staff Report for this Article IV consultation. We were in China in late June and the first part of this month, and our Executive Board considered the staff’s views in the Staff Report on Monday of this week.
Yesterday many of you will have also seen the public information notice on the Article IV consultation, which summarizes the views of the Executive Board. And today we're issuing the Staff Report for the Article IV consultation which clearly, I think, shows the views of the staff that were presented to the Board.
So I won't dwell on too much of an introduction, and perhaps just open it up to questions.
QUESTIONER: Hi, Nigel, and thanks for doing this again with the report in front of us. I have a couple things I'd like, if I could. I was struck by a statement on the currency discussion that if the Chinese forecasts prove accurate, then the undervaluation would prove negligible.
Now, you discussed yesterday how the staff's assessment is based on a series of functions, one being a stable exchange rate. But I was wondering, what's the chance in your mind that this whole discussion over currency really is going to end up being superseded by stuff the Chinese are doing on their own, which are not economy, that some combination of a little bit of appreciation plus a lot of internal reform will leave us at the end of the day about where we should be?
MR. CHALK: Yes, that's a good question. If you look at the stock report, we have actually a picture which I think pretty clearly summarizes the differences of views between us and the Chinese authorities. And as you see, if you look at our current account forecast, we believe that after this year, starting next year, or starting in the middle of this year, actually, and going through into next year, the current account surplus in China and the trade surplus will start to reassert itself.
The Chinese government actually doesn't agree with that view, and they feel the current account surplus will continue to decline from here and will level off at a range level of around four percent of GDP.
Now, as I said yesterday, our forecasts are based on a constant real exchange rate,which is the standard assumption that the Fund uses, and on the basis of the policies that have been publicly announced and are in place.
So we, in the Staff Report, lay out quite a comprehensive view of policies that we think will be needed. And what we see in the data in the historical pattern, is that, you know, going forward the global economy will be recovering, China will be beginning to unwind some of its fiscal stimulus and those forces will be quite strong and will make the current account tend to rebound.
In order to offset that rebounding in the current account and in order to get consumption growing faster, a number of reforms will be needed. These will be related to building up a social safety net, fiscal measures to encourage consumption, financial sector reforms, corporate sector reforms, and a stronger currency.
So given the complex task that the government faces, they will need to continue to put in place a broad package of policies to include all of those things. But our view is that with those policies in place, then we would see much stronger consumption growth in China, and we would see the current account decline. And I think in the end that lower current account is a common view of what both our view and what the government's view as the end goal.
QUESTIONER: Okay. So you think there is a chance that if they do all these things, then the current -- they might be -- it'll be part of the mix maybe, but they could get progress by doing some of this other stuff.
MR. CHALK: Yes, absolutely. I think we do not see the currency in isolation, but we see the currency as part of a broader package of reforms.
MR. CHALK: When you're dealing with something like this kind of macroeconomic engineering project which is so complicated, we think that you have to use all of the policy tools at your disposal. The currency is one of them, but its not the only one.
QUESTIONER: Okay, then if I could just one other question, and this is the first Staff Report to be released, I guess, in 2006. I'm just wondering, you know, sort of what the mood was in the discussions with the Chinese. Do you think that they became a little more attuned, a little more cooperative because they were stung so badly during the recession and realized, say, we really need to be part of this process? Or do you think it's because they felt they were being, you know, adequately quoted by the IMF and the UF?
MR. CHALK: We always had a very constructive relationship with the Chinese. You know, their decision on whether to publish or not publish a Staff Report is something that's a domestic issue that they decide themselves, and, you know, it is based on the content of the Staff Report also.
But in terms of the bilateral relationship we have as part of the Article IV consultation, it's always been very constructive. We have a very open dialogue with them. They don't always agree with our views, but I think, you know, part of our role is at least beginning a debate among the government and within China, among the academic community, among the private sector, as to what kind of policies might be needed. And I think in that sense we've always had a very healthy debate with the Chinese. And we have representatives in China that have a regular ongoing relationship there, and we travel there two, three, four times a year in order to have discussions with the Chinese. So it's a very open two-way dialogue, and they're not shy about telling us what they think about our ideas.
QUESTIONER: Thank you.
QUESTIONER: Nigel, I had a question also on the publication. As I understand it, after paragraph 22 in an earlier draft that was a fairly extensive footnote detailing the IMF calculations of undervaluation, and it went from five to 15, to 27 percent, depending on the functions.
There is no footnote of that sort in, or no explanation of that sort in the actual report. Was it removed, and was that one of the reasons that the Chinese, as far as you can tell, that the Chinese agreed to publication?
MR. CHALK: Yes, on the publication, I think the Chinese looked at the whole report. They assessed whether they thought it was a fair and balanced report, and also whether we reflected their views correctly in the report. I think that was more the determining factor of publication and, you know, whether they felt this was a fair and balanced view.
In terms of what's in the report, what we've published is what's in the report, and that is what's on the Funds website. That's all I can comment on.
QUESTIONER: Right, but can you say, can you confirm that there was in fact a footnote to the extent that -- or to the point that I was reflecting, or the point that I just made?
MR. CHALK: No.
QUESTIONER: No that there wasn't, or, no, you can't confirm?
MR. CHALK: I can't confirm it.
QUESTIONER: Okay. All right, thanks.
QUESTIONER: Yes, thank you. You mentioned that you went to the Liang Jo as well as some of the more normal -- the IMF visit. Why did you go there, and what did you learn?
MR. CHALK: Actually, every visit to China we always try and get out of Beijing/Shanghai, so this trip we decided to go to Lanzhou in Gansu Province. Our representative in Beijing also went to Suzhou and Guanzhou in the Yangtze River Delta area, Pearl River Delta areas, And we wanted to see what the economic situation was out West.
The main reason we do that is because the economy in the country is so heterogeneous that we feel if you stick to the coastal provinces, if you stay in Beijing, you don't really get a clear picture of how things are evolving. So we always like to go to one or two of the provinces, and this time we just happened to choose Lanzhou. There wasn't any strong reason, although we did want to go to an area that was agriculturally dependent. We wanted to go somewhere out west, somewhere that was perhaps less developed in order to get a different picture from that you may get in the richer provinces on the coastal areas.
In terms of what we learned there, I think, you know, most of it's reflected in the Staff Report. While we were there, we met with real estate developers because, as you know, in part of the Staff Report we were looking at the real estate issue and what was happening in property markets. And so that was quite a different picture than, for example, meeting with the developers in Shanghai or Beijing.
We also met with some of the local government investment vehicles in Lanzhou. Of course, we met with the government and the Central Bank, the Ministry of Finance. We also like to talk to local government finance bureaus which often can give us quite a different picture than what we see at the central level.
And we also talked there with the banking regulatory agency. Again the whole idea is just to build a broader picture, to get a different sense than you get from the capital and what you see in the capital.
QUESTIONER: All right, thanks. Could I just ask the tentacle question, Box 4 which, you know, looked -- projections for the current account that you've got two different models, one showing the fiscal policy actually made some (inaudible) difference, and the other one showing that it made quite a big difference.
Do you know why they come out in different amounts?
MR. CHALK: Yes, I think it's just the nature of the models. We try and approach it from a number of different ways. These are two of the models we showed in the Staff Report, but we also have other ones that we look at. And I think it depends on the nature of the model.
So the one model is a time series approach, so it takes the historical data and it looks at historical trends and runs a regression through the historical data to see what would happen, with very little structure placed on the model, letting the data speak for itself. And it turned out, in that model, fiscal policy doesn't seem to have a big effect on the current account in China, that that's just the nature of what we find in the data.
The second approach that we show, which is a structural monetary and fiscal model, which has more detailed structure placed on it in terms of the behavior of agents and governments. And in that model, we get a much larger impact of fiscal policy.
So the nature of the models are quite different, the assumptions underlying the models are quite different. And in China, because of the structurally changing nature of the economy, we try and, whenever we look at issues like this, we try and look at it from several different perspectives in order that we can still have some comfort that what we're saying is correct. And I think, you know, the models broadly gave a common view of how much the current account would rebound as the fiscal stimulus is unwound and as the global economy recovers.
But the nuances were a little bit different, and so we tried to present those different nuances in the Staff Report.
QUESTIONER: But then your staff judgment is quite different from either of the models, right, in the next couple of years?
MR. CHALK: Yes. With the models what we're trying to do is extrapolate from historical trends, but we also recognize that, even over the past year or year and a half, there has been significant structural change in China. For example, they've put in place a rural pension system which will help, we think, reduce precautionary savings and help lose consumption. So that's one aspect.
They've also started to roll out quite a major healthcare reform putting more money into healthcare, which again we think for the elderly, who are the ones that save quite a lot in China, that will reduce their incentive to save as they become more comfortable that there's a social safety net available to them.
And so while these models are extrapolated from historical trends, we try and overlay that with our judgment looking at, say, in the last year or year and a half how have things changed and how that might change the dynamic. And so I think relative to the models we do see probably a little stronger consumption than would be predicted by the models, a little bit lower savings and that's reflected in a lower current account forecast. But then, through time it begins to pick up toward the model predictions.
So I think the long run predictions of the model are consistent with where we see the economy going in our forecast. But, you know, some of the short-term dynamics are different, and even between the two models, the short-term dynamics are a little bit different.
QUESTIONER: I just wanted to get back to the primary issue. Why has China allowed the release of this report now for the first time since 2006? That's -- what's the answer for this, actually?
MR. CHALK: It's very hard for me to speak for the Chinese authorities on why. I can give you a broad sense of our discussions in China which perhaps will give some background. So when we were in China, we presented this view that we have in the Staff Report of what would be needed for rebalancing and we also presented a view of what more of the short-term issues were.
And I think what we found is that there was actually considerable agreement on many of these issues, on many of the reforms that might be needed going forward, on some of the structural areas on the importance of things like urbanization, on the importance of the social safety net. There may have been some differences of views on how fast some of these reforms will be done or ought to be done, but I think, in general, for the underlying reforms themselves there was quite a lot of consensus.
Obviously, there was a difference of view on the currency, and there was a difference of view on the prospects for the current account. But the underlying sense that we got in China was there is a strong commitment to the transformation of the economic model there. There's a strong commitment to moving to an economy that's much more driven by consumption and much less driven by exports and investment. And I think that's reflected in the Staff Report.
And as the second factor, I think, I would hope to believe the fact the Chinese decided to publish the Staff Report reflects a view on their part that the Staff Report was balanced, was fairly reflective of their views, as well as the staff's views, and gave an overall picture that was even-handed.
QUESTIONER: Yeah, just a quick follow-up on the economy itself. I mean going by the Staff Report itself, it bases mostly on the recovery taking place, but what if there is a double dip, for example, do you think the Chinese economy would be able to cope with such a dip?
MR. CHALK: I think it depends on the state of the expansion in the global economy. We talked in the Staff Report about the risks to China, and there are some domestic risks, and we pointed out things related to the credit expansion to real estate, of the local government financing vehicles.
But I think perhaps one of the bigger risks facing China is this risk to the global economy, and, as you know, in our world economic outlook that was released in July, we do point to those downside risks to the global economy, although we have global growth in a four to four-and-a-half percent range, which is the underlying assumption that this report was built on. We do recognize there are quite significant downside risks about that growth forecasts.
So China would be affected if there was a downturn in the global economy. We see the major effect coming through the trade channels, which is what you saw in 2008 and 2009. Net exports would become a bigger drag on growth, and then the question is, what would be the Chinese authorities' policy reaction be to that outcome? Our belief is that they have significant tools at their disposal to react in a countercyclical way to such a shock from outside. They can use fiscal policy; they could also loosen monetary policy again, and we think that this would provide a significant cushion to a lower global growth outlook.
Having said that, on fiscal policy our message was that, if you were to do that, if you were hit by another shock, we think it would be better to respond with fiscal measures, not as much in 2009 that were related to public investment, but rather fiscal measures that were much more related to private consumption. So things like reducing consumption taxes, perhaps reducing some labor taxation, directly subsidizing and providing incentives to consumption and investing more in the social safety net.
Now, those measures would not have as large a direct impact on the economy as, say, infrastructure spending, but I think they would help facilitate this transformation of the economic model and the shift towards more private consumption. And so, in the longer run, it would be better for the economy, even if there may be some short-run output costs from choosing those measures. Over the long run I think China would emerge with a much more balanced and strong economy.
QUESTIONER: Just one final question, sir. This in relation to the undervaluation, a substantial undervaluation of A-1, I think it, to be fair, the IMF should give at least how do you think how much more appreciation is needed at least in the near term or the medium term? Because by just leaving the issue in the air, just saying they substantially undervalued, I don't think it's fair to the Chinese authorities, for example.
MR. CHALK: Our view on the renminbi has always been based on a more medium term view. So we don't look as much, okay, how much over the next month or the next year do you need to move the currency? It's more related to what level of currency would be consistent, over the medium term, with an economy that has a smaller current account surplus that has a larger amount of consumption in the economy.
And when we make that view, of course, over time, the economy is changing: structural changes are happening, the terms of trade is changing, productivity is changing. And so I think it's very difficult over the medium term to give any particular point estimate of where exactly the currency should be.
So we've opted for this language that it's substantially below the level that's consistent with medium-term fundamentals to indicate that a stronger renminbi is needed. But exactly how strong that needs to be I think is quite difficult to say in part because the economy is changing so rapidly. So through time as the economy changes, the level of currency that's consistent with medium-term fundamentals will also change.
QUESTIONER: Good morning, Nigel. I was wondering on the issue of interest rates, there were some reports out yesterday saying -- which looked at the IMF's reporting -- and said that basically raising interest rates in China right now would lead to a lot of bankruptcies, and actually stretch the economy.
The question is what are you -- you know, if you're feeling that interest rates should rise very gradually, is -- do you have a time frame or measure of that?
MR. CHALK: Yes. I think what we see in the current system is that the government is trying to achieve the slowdown in credit growth for this year. There was a large expansion in credit last year, in excess of 30 percent of the GDP, and that created concerns about the quality of that credit in the banking system. So, quite rightly we think, the government is trying to slow that pace of credit growth this year.
Now, how do you achieve that? When they're targeting a decline in broad money M-2 growth that goes from somewhere around 30 percent at the end of last year to 17 percent by the end of this year, now, that's a pretty steep decline in monetary growth rate.
In order to achieve that decline in growth rates, we feel that all of the policy tools they have should all be pushing in the same direction. And those policy tools include interest rates, they include open market operations, they include changes in reserve requirement. And what we see right now is the government is quite heavily relying on direct limits on credit in order to achieve that monetary growth target, and we feel that somewhat of an unbalanced strategy, that more reliance should be put on interest rates.
In terms of where interest rates should go over the medium term, again I think that's a hard question to answer. Real interest rates now are close to zero, or at least for the deposit rate. They've always been quite low in China. They're particularly low when you compare real interest rates relative to the growth rate of the economy, and you look at that differential across countries (and we have a picture in the Staff Report that shows that).
That differential and that very low level of real interest rates creates all sorts of perverse incentives within China. First of all, it makes household income lower. The majority of the household savings are held in the banking system in deposits, and so over time, over the last decade, you've seen a secular decline in household capital income and partly because of lower real interest rates. In spite of much higher savings and much higher wealth accumulation in the banking system, interest rates have been low, and capital income has trended down as a share of GDP.
But that provides a drag on consumption because households have less income, less disposable income. At the same time, the low interest rates act as an incentive for investment, and you've seen very, very high rates of investment in China, and particularly high rates for investment in capital-intensive tradable industries, export-related industries.
And so we think that distortion in the economy of very, very low real interest rates, both from the household side and the corporate side, over time will need to be unwound, and that real interest rates will have to rise in combination with a number of other different policies including things like financial development and an appreciation of the currency.
And just as a quick plug, we're currently undertaking a financial sector assessment program in China. We just did one for the U.S., as you know. We're now halfway through one with China, and in the next year's Article IV consultation, we'll bring that assessment to the Board. As part of that assessment we'll be looking at these issues about how you change the cost of capital in China, how you develop the financial system, how you undertake monetary operations in a way that relies less on direct limits on credit and more on some traditional policy instruments like open market operations, changes in interest rates, and changes in reserve departments.
MS. UTSUNOMIYA: If there is no other further questions, we will wrap up here. The Staff Report will be posted on our website at 9 o'clock Washington time, which is about 25 minutes from now. That's when the embargo for this phone conference is lifted as well.
QUESTIONER: Sorry for the delay. It wasn't recognized in my key, but on consumption, it's quite a strong projection you've got for this year, the in point change advantage going to grow. Is that an unusually high figure, and what accounts for it?
MR. CHALK: Yes, the consumption forecast, I think that is relatively high, historically, that is a relatively high number. Why it's high is in part due to what we see in the fiscal accounts. The government right now is providing quite large incentives to consumption in terms of providing subsidies and incentives for purchases of automobiles and motorcycles, and purchases of consumer durables. So, in terms of timing, that will create some higher levels of consumption. And we've seen consumption through the first half of this year in terms of retail sales data (which is not quite the same as the national accounts numbers, but it's close), we've seen that doing relatively well for the first half of this year, and we think that will continue during the course of this year. Now, after that, our expectation is that some of those fiscal measures that will suggest these consumption measures will be unwound or at least scaled down, and consumption will go back to a lower path, but still a path that grows faster than GDP. So we're reasonably optimistic that you've seen a change in the secular decline of consumption as a share of GDP. We feel that bottoming out is about to turn -- is in the process of turning upward. And I think the challenge now is to sustain that dynamic and accelerate that dynamic so that you do get consumption as a much larger share of GDP.
The other thing that's feeding in to consumption is that we see quite strong wage growth in China, and we discussed that wage growth in the Staff Report a little bit. So in our discussions with many in the industrial sector, they gave us ranges of wage growth in the order of 10 to 15 percent nominal wage growth, which is a pretty healthy rate of wage growth.
And some people worry, well, that's a sign of shortages of labor in China that's going to feed into inflation. I don't think we're that concerned about that problem; in fact we see the increases in wages, including rises in minimum wage, as a relatively healthy development in China. It's a process by which labor will get a larger share of income from production, from value-added, than they've previously done.
So over time we expect and we hope the household disposable income and wages, both capital income and wages, will rise through time and will keep, not only keep up with productivity and nominal GDP growth, but will actually exceed nominal GDP growth.
So, yes, we have a reasonably strong consumption forecast for this year. It'll come down from that next year as part of the fiscal measures unwind But it will still stay at a reasonably high level, above GDP growth.
QUESTIONER: So you are from delayed of purpose question the (inaudible) that you (inaudible) think, it's the healthy, yet, but the way (inaudible). I suppose you delay, the costs go up. But you don't think that's a reflection of a bit of tightening in supply of labor?
MR. CHALK: Yes, I think, when you look at the labor market for -- that is the unskilled labor -- we don't see a tightening supply. There are regional supply shortages for sure, in some of the coastal provinces in particular. But overall, if you look at the economy as a whole, we don't really see particular signs that there is a lot of tightness in the labor market. What we do see is tightness in terms of skills.
So there is an emerging skills gap in China, and that is driving up the premium that skills demand in the labor market, and wages for skilled labor are going up must faster than the level of nonskilled labor. That was a consistent story that we heard from a range of private sector people we talked to, and also we talked to a number of labor placement firms and people who are involved in the labor market.
So it's a little bit of a nuanced picture. For unskilled labor, the bulk of the labor market, there does seem to us to be quite an adequate supply, although there may be some regional shortages which quite quickly get removed. The labor market in China works extremely flexibly, with mobility, geographically, and quite a lot of wage flexibility.
But having said that, in the skilled labor market, there are emerging signs of skills shortages, and you're seeing that with much faster wage growth for more highly-skilled labor.
QUESTIONER: Nigel, hi. I just want to follow up on that issue of the current account surplus. So the -- I'm assuming that what you were saying is that your all forecast is based on the level of recovery in on the WEO projections that the level of recovery is going to be pretty strong. Is that correct?
MR. CHALK: Yes.
QUESTIONER: And then so the Chinese, it is that they feel that the -- that exports are not going to be that strong and that the recovery is not going to be as robust as you are forecasting?
MR. CHALK: Yes, I think the trend is they have a growth forecast that’s a little lower than ours, in the high single digits. They have probably more concerns than the Fund in terms of the downside risks to the global economy. That's certainly the impression we got in talking them. The concerns, particularly on the situation in Europe, were probably greater than at least in our baseline forecasts in the WEO. So they probably are working with a slightly lower global growth forecast, and they end up with a lower China forecast.
They probably also, I think, would probably see our consumption forecasts as a little bit high.
QUESTIONER: All right. As over to the follow-up to what Bob Davis was bringing up regarding the footnote which was there and now it's been taken out. The question is, and we know from the Board's -- from talking to people in the Executive Board that many emerging markets didn't like the fact that the staff would publish those kinds ranges.
What is the benefit, then, of doing those kinds of ranges if they can't really be published, then?
MR. CHALK: When we look at the exchange rate and make that evaluation, that there is the need for a stronger currency, for the case of China, there's a lot of methodologies that are out there, and you can see a lot of analysts, a lot of academic studies, that give a wide, wide range for China on how much the currency may be undervalued.
We don't really like those numerical estimates. We look at them, and we look at a whole range of factors including outside independent analysts, their views. The reason is, for the case of China, there has been so much structural change over time. You've had this big shift in the mid-2000s with the current account moving into surplus. We feel for any of these quantitative estimates, which are trying to extrapolate and fit a model through that period of time, they just don't do a very good job, and they're not reliable.
Our assessment of the exchange rate is based on three much more broad points. First is that we look at the level of reserve accumulation and the level of foreign currency intervention, and we think about whether that degree of foreign currency interventions is consistent with what we might think of as equilibrium in the balance of payments.
And in China, as you know, foreign currency reserves have been accumulated very fast and now standing at close to $2 ½ trillion. That we don't -- we don't see that pace of reserve accumulation as consistent with equilibrium in the currency market. And so our interpretation is that, then, the currency is undervalued.
The second thing we look at is what is happened to the currency through time. And when you look at the Chinese real exchange rate, and we have measures in the report how you might measure that, including not only IMF measure but measures by the BIS, and we've also looked at ULC measure, looking at unit labor costs. And all of those measure come to the conclusion that the currency today is kind of in the range of where it was 2000, 2001, 2002, 2003.
So our assessment was that, during that period in 2001 to 2003, we didn't really see particularly strong signs of any disequilibrium in the balance of payments. But since then you've seen very, very strong productivity growth in China, much faster than in trading partners. So that strong productivity growth, to us, would suggest that if the currency were in equilibrium in 2002-'03, they should have appreciated between then and now in order that it's still in equilibrium today. And the fact that it is more or less at the same level tells us that the currency is now below where the equilibrium might be.
And the third issue is one that ties in to the current account surplus, and we discussed that. Our view is that as the global economy recovers and as the fiscal policy stimulus is unwound, the current account surplus will tend to reassert itself. Of course, you know, that's a forecast; we'll have to wait and see as to whether that's true. We think we see the signs in the last few months data of a beginning of an increase in the trade surplus which is not unexpected, and it's quite normal. And the question is, will that trade surplus now grow at a rate that's faster or slower than the rate of GDP growth in China?
And, you know, from our forecast as you can see, we expect the current account surplus to grow faster than the rate of GDP growth, assuming that they continue with the policies they currently have in place, and also assuming that they don't move the real exchange rate.
And so we end up with a current account forecast, over the medium term, going up to somewhere in the range of eight percent of GDP. That level of current account surplus we do not see as consistent with equilibrium in China. It's much larger than would be indicated by things like the demographics in China, things like the terms of trade, things like the prospects for productivity growth.
So all of those factors together are what we use in order to make our assessment of the current account surplus. And, you know, any particular point estimate or some particular model, we tend to take those a little bit with a pinch of salt.
MS. UTSUNOMIYA: Okay, we are going to wrap up this session. Thank you very much for participating.
MR. CHALK: Thank you.
* * * * *