Transcript of a Conference Call on the China Article IV

August 14, 2015

Washington, D.C.
Friday, August 14, 2015

MR. MA: Thank you. And good afternoon; and welcome to today's conference call on the conclusion of the annual review of the Chinese economy, what we call the Article IV Consultation, and the release of the Staff Report. I'm Dezhi Ma with the Communications Department at the IMF.

This is an embargoed conference call, I believe the Staff Report alongside our press release and survey story has already been made available to you, under embargo, earlier this afternoon. And the embargo will be lifted at 8:00 p.m. Eastern Standard Time, today, which is August 14th, that is 8:00 a.m. Beijing Time, Saturday August 15?

I have with me today, Markus Rodlauer, he is the Deputy Director of our Asian Pacific Department, and Mission Chief for China. And also Steve Barnett, he is Division Chief for China, at the Asian Pacific Department. Markus will offer a very brief opening remarks. We will then take your questions. Markus?

MR. RODLAUER: Thank you. And good afternoon to all of you, good morning those overseas; and thank you, first of all for joining this call. We appreciate that you do this, it's late on a Friday afternoon. It's not our preferred time to ask you to listen to us, and to engage in this, but I think we wanted to get this out, as soon as we had all the procedures completed for publication, instead of waiting until Monday. So, I will start with a brief overview of the report and recent developments, and then we will be happy to take your questions.

As discussed in our report, China's economy is undertaking a transition to a safer and more sustainable growth. This transition is challenging, but the authorities are committed to achieve it. They have made progress in reining in vulnerabilities built up since the global financial crisis, and have embarked on a comprehensive reform program.

We project GDP growth at 6.8 percent this year, down from 7.4 percent last year. As you know, we have had this forecast for a while now and it has been below consensus forecasts. Recent high-frequency indicators are consistent with the momentum we have built into our forecast for 6.8 this year.

The slowdown of China's economy from last year, which is broadly in line with the authorities' own target of around 7 percent, and Staff's recommended range of 6.5 to 7 percent; this slowdown reflects progress in addressing vulnerabilities, including slower total social financing or, in short, TSF growth, tighter oversight of shadow banking, a correction in real estate, and a new budget law.

While there has been much attention this week on the exchange rate, which I will come back to, we should not forget the substantial real effective appreciation that has taken place over the past year. As of July our estimate for this appreciation in real effective term is about 15 percent. This has brought the renminbi to a level that is no longer undervalued.

Even so, the external position is still moderately stronger than fundamentals, highlighting the need for reforms to reduce excess savings and achieve sustained external balance over the medium term.

On structural reforms, considerable work remains in implementing the authorities' reform agenda in the financial, fiscal, state-owned enterprises, and external sectors. Priorities are moving to a more market-based financial system; improving the management of government finances; leveling the playing field between state-owned enterprises and the private sector; and having an effectively-floating exchange rate within 2 to 3 years. The faster the progress, the sooner the growth-enhancing benefits will materialize.

Insufficient progress in containing vulnerabilities and advancing structural reforms continue to pose the biggest risk to the outlook. By that I mean, if they were going ahead, but with only insufficient progress; that would be the biggest risk. If that was realized, it could result, over the medium term, in a disorderly correction, and/or a protracted period of slower growth. Near-term domestic and external risks, however, are considered low, given existing buffers and policy tools.

Before I'll turn it over to your questions, let me touch upon two topics that have attracted considerable attention over the past month; the stock market and, more recently, the movements in the exchange rate.

On the stock market, after a big rally over the preceding several months, China's equity market corrected sharply in mid-June; our assessment is that the correction is unlikely to have a large effect on the real economy, and does not yet pose systemic financial risks. With regard to the government's response to support the market, while useful to prevent disorderly market conditions, our view is that that these measures should be unwound as soon as possible and the system's market orientation be restored.

Finally, on the change introduced earlier this week through the method for determining the central parity of the exchange rate versus the US dollar, we see this as a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will of course depend on how the new mechanism is implemented going forward.

Greater exchange rate flexibility is important for China as it strives to give market forces a decisive role in the economy, and is rapidly integrating into global financial markets. As I said earlier, China can, and should, aim to achieve an effectively floating exchange rate system within two to three years.

I should also mention, in connection with the ongoing review of the IMF's SDR basket, that the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the renminbi were included in the currency basket going forward.

With that, I would be happy now to take your questions, together with Steve.

QUESTIONER: You sort of addressed but just to elaborate a little more, I'm just interested in the sort of apparent bit of attention there is, on one hand in the text here, sort of nodding approvingly the appreciation of the exchange rate, and yet, also now nodding approvingly, the move to depreciate the exchange rate. There's seems a little inconsistency there.

MR. RODLAUER: Okay. Thank you. What we want to say is that with the significant real appreciation, over the last year, China has removed itself from having a clearly undervalued exchange rate, so the exchange rate has moved into the range of where we consider it no longer undervalued. When we say that we welcome what has happened over the past week, I want to be very clear that we do not specifically welcome a depreciation or a move of a currency in one direction or another.

What we do, however, welcome is the change in the system that has been made, whereby the central parity is now more closely linked to market forces than it was before. The central parity as you have seen is explicitly now linked more closely to the closing spot rate of the previous day, and that will, hopefully, allow going forward greater flexibility in the band, the central parity itself, in addition to the flexibility, the plus/minus 2 percent that the band itself allows.

So, you know, it's not that we have a view on the depreciation that has taken place. I believe it's less than 3 percent so far. That is a move in a currency that does not at this point affect our assessment that the renminbi is no longer undervalued.

QUESTIONER: Hi. Thanks for taking my question. You know in the report that the RMB is no longer undervalued, but in light of what has happened this week, have you reflected at all on that call, and have you considered, perhaps, that the renminbi, by contrast, was actually overvalued? That's my first question. And then, secondly, in the report, which of course, was written before the devaluation, you call for China to move to an effectively -- a floating exchange rate within two to three years, how far does this move this week get towards that? How close are they now to a really, freely floating rate? Thank you.

MR. RODLAUER: Thank you very much. First on the valuation of the renminbi, in the 2015 External Sector Report that was published last month, as well as in the Article IV Consultation Report, you have seen that we assessed China's external position in a multilaterally consistent external balance assessment, EBA (external balance assessment) framework. You know the framework that we have for that. It's an analytical framework that is fairly comprehensive and includes China, the country's fundamentals and policies.

In that exercise China's external position in 2014, as you know, was assessed to be moderately stronger, and the exchange rate moderately undervalued relative to what would be consistent with fundamentals and desirable policies. That was 2014. Then we saw the exchange rate appreciate in real effective terms, and the time of the EBA and Article IV assessment I believe it was 12.5 or 13 percent in real effective terms.

And that, in our judgment, even though we did not repeat the whole multilateral EBA exercise for 2015, but the very large appreciation, in our judgment, had moved the renminbi to a level that was no longer undervalued. Now, since then, I think the real effective exchange rate has moved a bit further in July to something like 15 percent, and now we have seen a depreciation by, you know, less than 3 percent if you take all three, four days together. So what has happened now over the past few days does not change our assessment that the renminbi is no longer undervalued.

How far does this recent move bring us to a truly floating exchange rate? Well, it really depends on how it is implemented. In theory when you have a system of a band that is plus/minus 2 percent with a central parity that is linked to the close of the previous day, you can figure out the math very easily, theoretically the exchange rate could, under this system, move by 10 percent in a week.

And that would bring us of course quite close to a float. Now, how is it implemented? There are of course other tools for the Central Bank to manage the exchange rate. The Central Bank is intervening to, like many other central banks, manage the exchange rate. So while the system itself would allow us to see a floating exchange rate with the plus minus two percent band and the Central parity linked to the previous close, the way it is going to be implemented will decide how flexible the rate in effect will be.

QUESTIONER: I just wanted to build a little bit on previous questioning. And in the report you talked that you have the, I guess, box nine, the report on foreign exchange system, and you talked about the increasingly critical need for greater flexibility in the exchange rate. Can you just talk us through why you think, or you thought then, it was becoming increasingly critical for the Chinese to make a move presumably like the one that they did this week, and two, can you tell us a little bit about the conversations that you were having back in May about how they might do that? You do say at one point in the report that one of the options there would be to change the way the midpoint is set every day.

MR. RODLAUER: Yes, thank you. Steve may help me on the reasons why we feel it's critical, so Steve, if you can add to what I say.


MR. RODLAUER: Bottom line is that we see an economy that is very rapidly integrating into global financial markets. While China still has fairly extensive de jure capital controls, we all know that de facto capital flows fairly easily across China's capital borders. We see, for example, the spread between the onshore and offshore exchange rate narrowing and being fairly small. Lots of indications are that China is quickly moving to an open capital account. Second -- this is one of the largest economies in the world that clearly needs its own independent monetary policy, adjusted to its own cyclical and economic needs, and there it's obvious for us economists that you cannot have the impossible trinity of capital controls, an independent monetary policy, and a fixed exchange rate. Eventually, very soon, as the more you open up the capital account, you only have the choice of adopting the foreign monetary policy or having an independent monetary policy and a floating, flexible exchange rate. And we believe, clearly, China needs a flexible exchange rate for its own monetary framework to be independent, and to be able to set its own monetary policy. -- Second, to have the exchange rate as a shock absorber to volatile capital flows that can often not be absorbed alone by other macroeconomic tools. So from these economic and systemic points of view, we believe that as China integrates more and more into the global economy, it will be increasingly important for them to really have a flexible floating exchange rate. Steve, so you want to add to that a bit and --

MR. BARNETT: No, no --

MR. RODLAUER: On our discussions with the authorities in the consultation. I think box nine is quite elaborate regarding the various options that exist and how we have seen other countries move from tightly managed exchange systems into more flexible ones, and eventually into a float. We have seen this through various mechanisms, either for example by widening the band gradually -- that's certainly an option that now China also has going forward, and which the authorities themselves are on the record that this is a step that they will take in the future. You can see the band perhaps going to three percent, four percent, five percent in the next few years, and therefore you give the exchange rate within the band more room to float, based on market conditions. And then you find a way to perhaps move the band itself around, either in a discretionary way as you see the market and the equilibrium exchange rate move, or as the Chinese now have done, you allow the market to indicate to you a bit where the band itself should move. So I think this is, as I said, it's one of the steps that they have taken to give them this option, to allow the central parity to move. Of course they always have the option of moving the spot trade during the day to where they want it to be at the end of the day and, therefore, to where the band opens the next day. But it does- it is a step that allows them and prepares for these moves of gradual transition from a very tightly managed system, linked to the U.S. Dollar, to one that is more open and more flexible, and more responsive to market conditions. I don't know Steve, do you want to add anything or --

MR. BARNETT: No, no, that's was all. I have nothing to add.

QUESTIONER: Hi, yeah, this is sort of a follow up on where we started and continuing the theme here. You do say in the report that you felt intervention should be limited to kind of smoothing out the rough spots I guess in this transition. So really, two things--do you regard the apparent intervention last week as consistent with what you recommended there, and given what the PBOC has explained subsequently the policy shift, and the market action of last week, how do you interpret their intent to manage this? Or are they going to manage it towards more of a float or are they going to manage it towards more of a –manipulating the spot rates to where they want it to be?

MR. RODLAUER: You know, these are really good questions. But sitting here in the U.S., a couple of days after they have made this change, I really hesitate to speculate. A) how they're going to manage it, and B) going forward, how this is going to evolve in the spot rate, and C)also, I hesitate to comment on the kind of intervention they may have done, because I don't frankly know myself exactly what they have done. So I would rather wait and see and tell you that this lays the basis for greater flexibility. A lot will depend on how they implement it. As we have indicated, we do not expect a float, s free floating system tomorrow, so we do expect some continued management of the exchange rate. We hope it will, as we have expressed in our advice, gradually lead to more flexibility into a float, within two to three years.

QUESTIONER: Hi, thanks again. I just wanted to follow up just quickly on one thing. That question I had of whether you had -- what you had discussed in terms of the mechanisms for greater exchange rate flexibility, can you tell us whether at that time, the Chinese authorities were saying to you that they would be moving within weeks or months to do something, and giving you any indication of that? Were you stressing a kind of level of urgency? I think what struck me in the report was the line, increasingly critical, the increasingly there, whether that's -- so I -- if you could just tell me a little bit more about the discussions there, and whether you had any forewarning that this week's move was coming?

MR. RODLAUER: One thing I want to say, when we discussed this with people at the Central Bank, mid-level officials, senior officials, as well as the leadership, there was very much a meeting of minds as to the ultimate objectives, which is market determination of prices in the economy, market determination of the exchange rate, independent monetary policy in China, as I have said, floating exchange rate. There was also a meeting of minds on the time frame, broadly speaking. And there was also a meeting of minds on why this is becoming increasingly important as we have said, as China wants to integrate itself and is integrating itself more and more into the global financial economy. When we discuss these kinds of issues with country authorities, we would not expect them, frankly, to tell us what their immediate intentions are. That is not the purpose of our engagement. And I do not want to go into more detail about the specifics of our discussions, but the immediate steps in the next few weeks or so are never really subject of our discussions, in a consultation like that.

QUESTIONWR: Hi. Just a quick follow up on valuation. I think you said that the currency moves over the last week haven't changed your assessment that the RMB is no longer undervalued but can you now say that it's fairly valued? Is it now fairly valued at the level of that?

MR. RODLAUER: I would rather stick with what I said before -- no longer undervalued. As an aside, when we do these assessments, we think very carefully about the language that we use. I would like to stick with, no longer undervalued at this point. I would also emphasize that, as David Lipton pointed out when we were in Beijing in May, that this is an assessment based on current circumstances and that it may change, either it may change because of what happens to the renminbi exchange rate, or it may change because of what happens to other exchange rates, cross exchange rates, Dollar, others, or fundamentals. So this is an assessment made in May 2015, in the middle of 2015, and we are sticking to it at this point. No longer undervalued remains our assessment.

QUESTIONER: Yes, thanks for taking my question, and it seems the market, Private equity the China's move to improve its foreign exchange system, that is under way, some pathetic outlook for the Chinese economy. And can you elaborate more about the future outlook of the Chinese economy and it seems like so bad, as the market expected. Thank you.

MR. BARNETT: I can take that.

MR. RODLAUER: Maybe I can ask Steve to comment on our assessment of the growth outlook for China and the broader outlook for reforms.

MR. BARNETT: Okay. Our outlook for the economy is broadly aligned with what we had at the time of the May consultation, that is growth this year of around 6.8 percent. When we look at the high frequency indicators that have been coming in since the report was written, it reaffirms our view that growth is on track for our forecast of 6.8 percent, which is broadly consistent with the government's forecast of growth around seven percent for this year. I think when we look at the growth outlook, the challenge has been that some of the high frequency indicators related to the supply side of the economy, such as electricity production or industrial value added, often show so much slower growth than the headlines secures. However, what that misses is that industry, the secondary sector, is becoming a smaller share of the economy, and increasingly the service sector, or the tertiary sector, is becoming a larger share. In fact, this already has the largest share of employment in the economy. And the strength of the tertiary sector data have been holding up well, so we see kind of this continued trend of maybe somewhat slower supply side indicators in manufacturing, with continued strength and resilience in the service sector. And maybe just to add to that, the service sector also is more labor intensive so we see that the labor market is holding up well, and then that in turn supports consumption, and we see that in high frequency consumption indicators, they're also holding up well.

QUESTIONER: Hi, just to clarify the terms here. I know it's embargo delay, but we are on the record.

MR. MA: Yes, we are on the record.

QUESTIONER: Okay. Thank you.

MR. MA: If we have no more questions, then we will conclude the call, and let me just remind you again that this is a call under embargo, and the embargo will be lifted at 8 P.M., Eastern Standard Time. And that is tonight, and 8 A.M. Beijing time, Saturday August the 15th.


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