Transcript

With Steve Dunaway, Deputy Director, Asia and Pacific Department
International Monetary Fund
Washington, DC, November 1, 2006

MS. BHATT: Good afternoon. I am Gita Bhatt, Senior Press Officer with the IMF. Welcome to this conference call, and thanks to all of you for joining in.

This is a conference call by Steven Dunaway who is the Deputy Director of the Asia Pacific Department of the IMF, and the Mission Chief for China. Steve is here to answer any questions that you may have regarding the 2006 Article IV Staff Report on China, which as you know was posted on our website today. You may have already seen the China PIN that was published on September 11th.

Before we begin, let me just briefly go over the ground rules. This is an on-the-record conference call, embargoed until 5:30 p.m. Washington, D.C. time. We can proceed directly to questions.

QUESTION: I had a couple of questions, if I may. First of all, China's external surplus has really surprised everybody this year by its strength. I believe it has also turned out considerably stronger than you were expecting in your forecast. Could you talk a little bit about whether you have been surprised by the strength of net exports and whether you will consider revising your own estimates of this going forward?

Secondly, I wondered whether your comments about the currency, which obviously were effective in May of this year, still hold today.

MR. DUNAWAY: To your first question, yes, certainly, based off the data that is available for the first 9 months of the year we would revise up our forecast because the first 9 months on trade alone you exceeded the surplus for last year. Exports have maintained very strong growth, while we had probably expected somewhat slower growth than it turned out. And I think on the import side, the imports have not increased as much as we had thought. So we would tend to mark up our forecasts for both the trade and the current account balance at this point.

QUESTION: Going into next year as well?

MR. DUNAWAY: Into next year as well, yes, because the question is in terms of what would change the level, and you would growing off of a higher base and so that would probably tend to increase next year as well.

With respect to the exchange rate, in the past few months we have seen a more rapid rate of appreciation in the Renminbi than we did in the first part of the year. However, we would still tend to believe that there needs to be a faster rate of appreciation. The primary reason in the short-term is related to macroeconomic control and the key problem is very rapid investment in credit growth, although the numbers have come down some reflecting some of the policy measures that have been taken.

This is an old problem. Over the last 3 years, the key macro problem has been rapid investment, and through most of the period very rapid credit growth. What we see as a more permanent solution to the problem is the need for greater use of monetary policy. A concern is that if you do use monetary policy mechanisms, particularly open market operations, more aggressively, that would have a tendency to bid up interest rates and that might attract additional capital flows and then complicate this process of a very slow appreciation of the currency.

So just in terms of being able to exercise better monetary control, we think what is needed is greater flexibility in the exchange rate. And equally important in that is probably giving the People's Bank of China more discretion in setting both interest rates and the exchange rate so that they have more latitude to operate with monetary policies.

QUESTION: There is this whole debate going on—is China winning the battle to slow the economy. Do you think it can do more just through administrative controls? What else is needed there? Or do you think that the pace it is going and the way it is going now is sufficient?

My second question is I would like just to hear a little bit about your take on Paulson, the new U.S. Treasury—his new strategic economic dialogue with China. Do you think that this is the way to go to resolving these issues?

MR. DUNAWAY: On your first question, I have considerable doubts that they are winning the battle with administrative measures that they have put in place so far. As I say, this is an old problem and not a new one. In each of the last 3 years it has been a question that we have been looked at, so I think that kind of reflects on how effective over time the administrative controls are.

There is also a problem as we point out in the report that to some extent that the Chinese are kind of working against themselves with respect to financial reform, this use of moral suasion to try to get the banks to limit lending directly contradicts all the efforts they are making to try to get the banks to operate on a sound commercial basis and to make lending decisions based off of risk. So they are working at cross-purposes there.

What we see as the key way at the end of the day in winning this battle is, as I said in response to the first question, they need greater latitude to be able to operate monetary policy and that would entail greater flexibility in the exchange rate and more discretion for the PBC.

With respect to Mr. Paulson's strategic approach, there is much in what he is talking about that is very similar to the advice in the paper, particularly when the emphasis on the financial sector. We see the reforms in the financial sector in the short- to medium-term, as being extremely important as part of this process of reorienting the Chinese economy away from this very heavy dependence on investment and exports to generate growth, and more toward consumption as the key driver of GDP.

QUESTION: If I may, I will take this chance then to have another crack. I just want to ask about corporate savings. A number of recent reports and commentaries have highlighted a high level of corporate savings as being in many ways a key to understanding the savings and investment imbalance in China. I wondered if you would talk to us a little bit about that, whether you see corporate savings as being a sort of fundamental component of this and the importance of the dividend proposal you have in the Staff Report.

And if I may, a second question, which is am I right in thinking that your comments on the currency in the Staff Report are more unequivocal on undervaluation than they have been even in the past?

MR. DUNAWAY: Let me answer the second one first. I am not quite sure what you mean. If you look at the evaluation of the exchange rate over the past several years, over the past three Staff Reports that have been published, you will see that it has evolved in terms of the qualification of the extent of undervaluation in a qualitative sense, and that, yes, we do think that the exchange rate now is probably more undervalued than, for example, it was 2 years ago, but then that is also a reflection of developments in the balance of payments.

On corporate savings, again, if we look at the savings and investment balance, there is a huge challenge in looking at this in China because of the data problems, but we know that we have seen a big increase in the current account and part of the increase in the current reflects the fact that the fiscal position has been consolidated. But then there is a large remaining portion which has to be the private sector in China, or I should say, the non-government sector in China. We know that over short periods of time that household behavior tends not to shift dramatically, so that then leads us to the conclusion that it has to be corporate savings that accounts for a lot of this, and then that in turn kind of fits well with this assessment of the exchange rate and the improvement in the external account, that those two things are key drivers of some of this increase in corporate savings.

Part of it, too, is also a reflection of what is happening with commodity prices, in particular the large state-owned firms that are in the commodity-producing industries in China. They are some of the ones that have seen the biggest increase in their profits over the last few years.

So that in turn then leads us back to this advice on dividend policy, and there the key is, that at the end of the day, the owner of these corporations is the government and the government should get a return on its initial investment, and the question is, who can make the best choice in terms of how to use those funds, the firm or the government, and if one of your concerns is that these firms which tend to be in the very capital-intensive sectors in the economy and some of those are where there may be some significant overinvestment, that if these firms are plowing the money back into their own industries, that may not be the place that gives the highest social return on this capital to all of China.

The other aspect is just in terms of corporate governance in terms of being able to ensure that the firms operate on sound commercial principles, that if there is this obligation to pay dividends back to the budget that that will increase the oversight role of the government in this. So those two things influenced this decision on dividend policy.

But as to our recommendation on dividend policy, I think one key aspect of it that has an effect in terms of the current state within China is that we firmly believe that this money should go to the budget. There is this conflict now or at least this argument now between the SASAC, the government agency which manages the state assets and the Ministry of Finance over who should receive the dividends. We think the dividends should go to the budget which is ultimately where the initial capital investment came from.

QUESTION: I just wonder if you sense any greater willingness on the part of the Chinese authorities to heed the IMF's advice since the decision at the Annual Meetings to increase its voting power?

MR. DUNAWAY: I can't say. I always hope that it is my ability to make a very persuasive case on the policies that influence them, but at any point in time I have no idea.

QUESTION: A couple of questions, Steve. China is approaching the end of the schedule established in the WTO entry, but there are some concerns, a number of developments that suggest that China may be stepping back in some areas. This was outlined in the U.S.-China Business Council. Do you have any comment on that?

The other one is since the Article IV was done a while ago, are you maintaining the 10-percent growth forecast that you've got for China?

The third question is, as you know, there has been a lot of hooha about China lending to Africa and I want to know if you have raised this or they have raised this at all during your discussions and what that strategy is or anything that might point to the fact that they had this growing interest in Africa?

MR. DUNAWAY: On the first question, that is something that we are looking at. There will be a staff visit to China in December and we will look at where they stand on the implementation of some of these key WTO requirements. Most notably, the one is in terms of the treatment of foreign banks and the opening up of local currency business for foreign banks. We will be taking a look at that.

On the forecast, again, based off of the data that we have year to date, we would revise up the growth forecast for 2006. If I remember correctly, the revision would be up to at least 10-1/2 or maybe a bit higher.

On this question about lending to Africa, this is touched on in a couple of places in the report. For example, in paragraph 68 of the report, we acknowledge the work that China has done particularly in providing debt relief to many low-income countries and we encourage them to exchange information on their activities in the low-income countries. And paragraph 50 of the paper also relays the discussion of this issue.

QUESTION: Are they quite sensitive about this issue? Do they feel that it is kind of blown out of proportion? Can you give me any kind of feel for that?

MR. DUNAWAY: Given the commentary from the Chinese officials, I think you can draw a conclusion from that. But as I said, from our point of view, the key question or the key issue that we raised with them was in terms of the sharing of information and encouraging them to consider the overall debt positions of these countries in determining any business transactions that they are doing.

QUESTION: : I just wanted to follow-up on one thing you said, and I have another question. You did say that growth for this year would be 10-1/2 and maybe up. I just wanted to make sure I heard that one correctly.

Second, as far as the suggestions you have made, are these suggestions that have come into play at all more along the lines of how is the progress going with these suggestions in the multilateral communication/surveillance program that the IMF has started? Has that had a whole lot of success, or have you been dealing with that at all?

MR. DUNAWAY: The answer to your first question is that, yes, we would estimate that growth this year would probably a little bit over 10-1/2 percent.

On your second question, in the context of the multilateral consultation, I am not directly involved, but the Fund's position vis-à-vis the country and looking at the global imbalances problem and the policy prescriptions, this has all been outlined in the context of the World Economic Outlook reports in talking about the problem of global imbalances, and the key policy recommendations there are all drawn from the Staff Reports from the major parties involved.