China’s Role in the Current Global
Economic Adjustment Process
Li-Gang Liu
School of Public Policy
George Mason University
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Structure of the presentation
I.
II.
III.
IV.
V.
Introduction: The Renminbi
Controversies
Nominal Revaluation and the Sino-US
Trade Imbalances
The link between overheating and the
“undervalued” renminbi
Optimal exchange rate regime for China
What’s China’s role in the current global
imbalances
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I. China’s Currency Controversies
z
z
z
China was first blamed for exporting deflation to
the world economy because of its undervalued
currency. Thus China was called to either revalue
the renminbi (RMB) or reflate the economy
(Kuroda and Kawai, FT, 12/2/02).
While China’s existing trade positions make it an
unlikely force for world deflation, the calls for
China to revalue gained attention in Washington
DC.
Despite China’s overall trade surplus with the rest
of the world is rather small, 2% of GDP (2001),
Sino-US trade surplus remains large (10 percent
of China’s GDP).
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z
z
Because of large losses of US manufacturing jobs
(2.7 million) and the politics of the presidential
election year, the Bush Administration has been
pressured to act.
Trade front:
•Quotas on 3 fast growing categories of Chinese
textile/garments
•Anti-dumping duties imposed on Chinese-made
TVs (up to 78%)
•Anti-dumping duties are under review on
Chinese-made furniture
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z
Financial Front:
• Pushing for RMB revaluation: Treasury Secretary John
Snow and Commerce Secretary Don Evans spoke
repeatedly in public that RMB needs to revalue to reduce
the US-China trade deficit.
• Fed Chairman Alan Greenspan also publicly raise the
RMB valuation issue from the view that large inflow of
capital will make the current RMB-dollar peg
unsustainable. Therefore, RMB would have to be
revalued to reflect the market pressure.
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z
z
Some have put a specific figure for RMB’s
revaluation:15-25% (Goldstein and Lardy, 2003)
but the methodology is unclear. China is also
suggested to move on to a flexible exchange rate
regime by adopting a basket peg of dollar, yen and
euro or a crawling peg.
But a market based RMB-dollar exchange rate,
the non-deliverable RMB-dollar future rate, does
not indicate a large undervaluation of the RMB.
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Daily rate from 01/08/96 to 05/17/04
Source: (1) 1996-97: Prebon Yamane (Hong Kong) Ltd. (2) From 1998 onwards: Reuters, and HKMA
7
2004-5-1
2004-2-1
2003-11-1
2003-8-1
2003-5-1
2003-2-1
2002-11-1
2002-8-1
2002-5-1
2002-2-1
2001-11-1
2001-8-1
2001-5-1
2001-2-1
2000-11-1
2000-8-1
2000-5-1
2000-2-1
1999-11-1
1999-8-1
1999-5-1
1999-2-1
1998-11-1
1998-8-1
1998-5-1
1998-2-1
1997-11-1
1997-8-1
1997-5-1
1997-2-1
1996-11-1
1996-8-1
RMB/US Dollar
Figure 1: Non-Deliverable Forward RMB-Dollar Rate
10.0000
9.5000
9.0000
NDF RMB/Dollar
8.5000
8.0000
RMB/Dollar
7.5000
z
Indeed, China’s underlying structural
weakness does not warrant large RMB
revaluation:
• It’s banking system is still fragile (Large NPLs and
weak risk management).
• It’s medium-term fiscal sustainability remains a
challenge (contingent fiscal liability exceeds 100
percent of GDP).
• Domestic structural imbalances pronounced
(significant rural-urban, regional, and income
inequality and huge unemployment pressure).
• Economic transition still unfinished and quality
institution yet to emerge.
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z
z
z
China’s recent soaring growth and its
insatiable appetite for raw materials from
the rest of the world have also been blamed
for causing rapid rise in commodity prices.
“Undervalued” currency was thought as one
of the causes of macroeconomic overheating.
China’s renminbi has been blamed for both
world deflation and inflation.
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II. Dealing the Sino-US Trade Imbalances
z
An RMB revaluation won’t help reduce
the US trade deficit and won’t restore
the Sino-US trade balance, either.
•US savings-investment imbalances
fundamentally determine its external
imbalances.
•Thus, an RMB revaluation will only have
redistribution effect of US trade deficit with
the rest of the world
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z
Four underlying factors help explain the
Sino-US trade imbalances
1)
China’s processed trade structure and the
East Asian trade triangle (Processed
trade dominates China’s trade structure
and contribute to the trade surplus while
the ordinary trade originated from
domestic firms remains a weak link).
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China's Trade Surplus with Key Trading Partners
40,000
Taipei, China
South Korea
Japan
30,000
EU
United States
20,000
Millions of US dollas
10,000
0
-10,000
-20,000
-30,000
-40,000
1995
1996
1997
1998
1999
2000
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2001
12
2) The 1998 value-added export-rebate tax
can be removed before considering a
nominal revaluation.
• The rebate is outmoded and too expensive
to maintain ($24 billion or a quarter of
China’s trade surplus)
• Big fiscal burden and backlogged,
endangering government credibility
• Bad for China’s terms of trade.
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Declining Terms of Trade with Key Trading Partners (1993- 2000)
Products
USA
EU
Japan
All products
- 23
- 28
- 26
Non- fuel Primary Products
0
- 36
4
Manufactured Goods
- 24
- 27
- 28
- 12
- 37
Labor or Resource Intensive Product - 48
Low- tech Products
- 27
- 36
- 15
Medium- tech Products
- 42
- 28
- 31
High- tech Products
13
- 23
- 35
NIEs
- 17
5
- 20
-2
-5
- 28
- 29
ASEAN
-8
34
- 24
-9
- 14
- 26
- 43
Source: Zheng and Zhao (2002) based on statistics from the Chinese Customs Statistical Year book
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Other LDCs
-3
15
- 21
7
- 13
- 59
-7
3) Large reserves of labor exert downward
wage flexibility and upward wage rigidity.
•Large urban unemployment (10 to 15
percent) and the rural under employment
(150-200 million) determines China’s
comparative advantage in labor intensive
industries for a long time to come.
•Real wages in the export sector have not
seen much change ($100 for more than 10
years).
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4) Fiscal incentives in its FDI regime further
underscores the trade competitiveness.
• Both central government and local government
fiscal incentives provided are generous: 2 years of
no income tax and the following 3 years by half, in
addition to generous local government concessions
in land, energy, bank loans, raw materials, and
labor usage.
• Such fiscal incentives may help China’s quantity
success in attracting FDI but not quality success in
attracting large-scale and tech-heavy FDI.
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z
z
z
The Four structural factors ought to have
contributed to RMB’s competitiveness in
international trade.
China could indeed first address these distortions
before considering any nominal appreciation of
RMB since no one knows the equilibrium
exchange rate with these distortions in place.
It is also in China’s interest to address these
distortions because they are potential
impediments for China’s long-term growth.
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z
z
z
These structural factors are bad for China’s TOT
which may lead to immiserizing growth, brought
by biased anti-trade technical progress (Harry
Johnson, 1958).
They are also bad for regional and income
distribution because fiscal subsidies biased toward
fast growing and profitable export sector and
individuals.
Furthermore, these policies are also not in line
with China’s WTO commitments.
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What China could do to address the Sino-US
trade imbalances?
• In the short-run, phase out or even revoke the
export tax rebate tax since it is out of date and too
expensive to maintain as China’s export growth is
fast growing and no need of further stimulus.
• The policy also removes distortions: other sectors
are subsidizing the most profitable and faster
growth sector of the economy. It does not make any
economic sense.
• In response to the pressure from the US, China can
simply draw a shopping list and deal with the US
deficit bilaterally (import diversion).
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• Improve FDI regime:
China needs to take steps
to make its FDI policies in line with the Trade-
Related Investment Measures (TRIMs).
• Fiscal incentives are less important than a
predictable, mature, and transparent FDI regime
(JBIC Survey and McKinsey Study)
• Less emphasis on fiscal incentives and more on
enforcement of contract, investment transparency,
and policy predictability.
• Ensure FDI’s quality success (High-tech contents
of OECD FDI).
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III. The link between overheating and the
“undervalued” renminbi
z
z
z
z
z
The current cycle of rapid growth is no different from
the previous cycles mainly spurred by rapid bank
credit growth.
Bank lending to property sector and automobile sector,
facilitated by mortgage and consumer finance, led to
way.
Five sectors (real estate development, steel, electricity
generation, automobile, and chemical sector) accounted
for 59 percent of total fixed asset investment
Fixed asset investment reached to 43 percent of GDP,
one of the highest in history.
Electricity consumption, a good measure of GDP
activity, soars.
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F ig u r e 3 : E le c tr ic t y G e n e r a t io n a n d G D P G r o w th R a te
3 0 .0 0
2 5 .0 0
1 5 .0 0
1 0 .0 0
5 .0 0
02
01
00
99
98
97
96
95
03
20
20
20
20
19
19
19
19
93
94
19
19
92
91
90
89
88
87
86
E le c tr ic ity G e n e r a tio n G r o w th R a te
19
19
19
19
19
19
19
19
84
85
19
19
82
81
80
79
78
77
83
19
19
19
19
19
19
19
76
0 .0 0
19
Percent
2 0 .0 0
G D P G r o w th R a te
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20
-5
CPI
Food
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03
-1 0
G r a in
23
20
20
20
04
04
04
-4
-3
-2
1
-1
-1
-1
-1
2-
1
1
-1
-1
-1
-1
-1
-1
-1
-1
1-
-1
-1
1
1
-1
0-
-9
-8
-7
-6
-5
-4
-1
04
03
-2
-3
-1
03
03
03
03
03
03
20
20
20
20
20
20
20
20
03
03
03
-1
2-
1-
1
-1
-1
-1
-1
-1
-1
-1
F ig u r e 4 : O v e r a ll C o n s u m e r , F o o d a n d G r a in P r ic e
20
20
20
20
-1
-1
1
1
1
-1
0-
-9
-8
-7
-6
-5
-4
-3
-1
03
02
02
-1
2-
1-
-2
-1
02
02
02
02
02
02
02
02
02
20
20
20
20
20
20
20
20
20
20
20
20
-1
-1
02
01
01
-1
-1
-1
-1
-1
-1
-1
-1
-1
0-
-9
-8
-7
-6
-5
-4
-3
-2
-1
-1
01
01
01
01
01
01
01
01
01
01
20
20
20
20
20
20
20
20
20
20
20
20
Percent from the same month in previous year
Inflation rate accelerates
In d e x e s
40
35
30
25
20
15
10
5
0
z
z
Food price, in particular, grain price increased sharply,
largely due to reduced incentives to plant grains and
consequently the land devoted to grain production.
But the current inflation will not become a run-away one,
unlike the previous ones.
• Consumer goods supply still exceeds demand (473 out of
600 consumer products still face oversupply)
• There is no sign of wage led inflation
• Domestic demand still weak (consumption share in GDP
is only 60%, compared with74% for LDCs and 80 for DCs).
• Increased grain imports and increased acreage to grain
production
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Does an “undervalued” currency cause
rapid M2 growth?
•Conventional wisdom links rapid M2
growth rate to the undervalued currency:
An expectation of revaluation led to capital
inflows, thus increase the central bank
asset base and monetary supply if it
becomes difficult to sterilize.
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Table 8: Current account balance, capital account balance, reserves accumulations and M2 Growth (Billions of US Dollars)
1998
Current Account
29.3
Capital Account
-22.8
Foreign Direct Investment
43.8
Other capital flows
-66.6
Change of Reserves
6.5
Total Reserves
146.3
Reserve Growth
4.6
M2 Growth
14.8
Credit Growth
15.5
Source: Calculated from data publised on PBOC's website.
Note: a. Figure for 2004 is for January to March 2003.
1999
15.7
-7.1
38.8
-45.9
8.6
154.9
5.9
14.7
8.3
2000
20.5
-10
38.4
-48.4
10.5
165.4
6.8
12.3
6.0
2001
17.4
29.9
44.2
-14.3
47.3
212.7
28.6
17.6
13.0
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2002
35.4
40.1
49.3
-9.2
75.5
288.2
35.5
16.9
16.9
a
2003 2004
29.5
90.5
54.7
35.8
120
408.2
41.6
19.6
21.1
26
-7.8
n.a.
n.a.
n.a.
113.5
439.8
39.2
19.1
18
Relations among reserve growth, M2 growth, and Total Loan Growth
160.0
140.0
120.0
Percent
100.0
80.0
60.0
40.0
20.0
0.0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
-20.0
M2 Grow th
Reserve Grow th
Loan grow th
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2003
But empirically, the linkage is weak
Table 9: Granger Causality Test between M2 and Foreign Exchange Reserves
Dependent Variable: M2
Variables
M2
Foreign Exchange Reserves
F-Statistics
10.53
0.67
Significance
0
0.75
Dependent Variable: Foreign Exchange Reserve
Variables
F-Statistics
M2
2.57
Foreign Exchange Reserve
52.7
Significance
0.04
0
Source: Calculated by the author
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Rapid M2 growth has more to do with
1.
2.
3.
Competition to get listed: Incentive to grow out of
NPL problem by expanding the balance sheet (if
loan growth is 10 a year, 7 years NPLs will be
halved).
Interest rate liberalization: lending rate first (at a
range of --10 percent and 170 percent from 5.31)
and deposit rates (1.98%) lead large interest rate
margin. Thus it is profitable to lend.
Local government influence on bank lending
remains.
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Will China have a hard landing?
• Other than the central bank efforts to use OMO and raise
reserve requirement, a coordinated administrative efforts,
which are perhaps more effective, have been taken to
cool down the economy.
• Various indicators such as fixed asset investment growth,
industry output, money supply and bank credit have all
shown signs of slow down.
• Capital inflows is likely to reverse because the high
probability of interest rate hike by the Fed.
• The end result of the overheating in some sectors will be
more NPLs in the banking sector and deflation may also
resume.
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IV: An optimal exchange regime for China
Which exchange rate regime performs better in the
long run?
Table 11: Performance of Exchange Rate Regimes
Classification Scheme
Peg
Annual Inflation Rate
Standard
38.8
Dual Rates
20.7
Per-Capital GDP Growth
Standard
1.4
Dual Rates
1.7
Source: IMF, World Economic Outlook.
Limited
Managed Freely
Flexibility Floating Floating
Dual or Multiple
Exchange Rates
5.3
10.1
74.8
29.7
173.9
45.5
n.a
167.4
2.2
2.6
1.9
1.5
0.5
1.1
n.a
0.8
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What exchange works better for China?
Table 10: Exchange Rate Regimes
I. Fixed Arragements
a) Currency Unions
b) Currency Boards (Dollarization)
c) Truly Fiexed Exchange Rates
II. Intermediate Arrangements
a) Adjustable Pegs
b) Crawling Pegs
c) Basket Pegs
d) Target Zone and Bands
III. Floats
a) Managed Floats
b) Free Floats
Source: Frankel (1999)
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As China’s capital account has become more porous, its
objective of maintaining stable exchange rate and autonomous
monetary policy simultaneous becomes increasingly untenable
Figure 5: The Trilemma
Stable Exchange Rate
Capital Control
Currency Board
Floating Exchange Rate
Autonomous Monetary Policy
Free Capital Flows
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z
z
Indeed, in order to maintain stable exchange
rate and conduct independent monetary
policy, China should strengthen, rather than
weaken, capital controls.
The existing pegged exchange rate regime
offers advantages:
• To prevent time inconsistent policies because of the
lack of credibility of domestic institutions
• Leverage on better institutions for credibility
• Allow time to build domestic institutions and
convergence to center
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China’s institution quality is not up to handle
domestic financial liberalization
d o m e s ti c fi n a n c i a l l ib e ra li s a ti o n a n d c o r e i n s t it u t io n s i n th e l a t e
1990s
12
core ins titutio ns
10
H K
8
S IN
M L
C H
TW
ZA
6
C Z
AR G
C OL
BR
4
IN D
PE
MX
TK
VEN
KR
PH
ID
PL
2
TH
H U
SA
CN
R U
0
0
10
20
30
40
50
60
70
80
90
100
d o m e s tic f in a n c ia l lib e r a l is a t io n
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China’s core institutions are not up to the job
of capital account liberalization, either.
c o r e i n s t it u t i o n s a n d c a p i t a l a c c o u n t o p e n i n g i n t h e l a t e 1 9 9 0 s
12
core institutions
10
HK
ML
8
4
VE N
CH
ZA
TW
TH
IN D
ARG
6
COL
KR
BR
PH
TK
PL
2
S IN
PE
CZ
MX
HU
ID
SA
CN
RU
0
0
0 ,5
1
1 ,5
2
2,5
3
3 ,5
4
4 ,5
c a p i ta l a c c o u n t o p e n in g
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China’s core institutions are generally weaker than
some of the crisis economies.
T a b le 1 : C r is is E c o n o m y P ro f ile s c ir c a 1 9 9 0 s
C o re
I n s tit u t io n s
In d e x
S c a le 0 – 1 0
I n t e r n a tio n a l
L e v e ra g in g
I n t 'l b o n d & b a n k
d e b t/G D P %
1998 Q 2
E x te rn a l
L iq u id it y
C o n s tr a in ts
S h o rt-te rm
F u n c tio n a l
d e b t/F X re s e rv e s % D F L %
Sept 1998
S in c e 1 9 8 0 s
KAO
1 9 9 8 -9 9
S c a le 0 – 4
A r g e n t in a
B r a z il
P e ru
M e x ic o
I n d o n e s ia
K o re a
M a la y s ia
P h ilip p in e s
T h a ila n d
T u rk e y
R u s s ia
5 ,0
4 ,6
5 ,2
4 ,7
3 ,4
5 ,1
8 ,0
4 ,1
5 ,4
3 ,7
1 ,1
2 3 ,1
1 7 ,3
1 3 ,2
2 6 ,0
4 2 ,2
2 9 ,9
3 6 ,5
2 8 ,3
4 0 ,8
2 4 ,3
1 6 ,1
1 5 9 ,0
1 1 4 ,0
7 4 ,0
8 2 ,0
7 5 ,0
1 7 3 ,0
2 7 ,0
6 4 ,0
4 8 0 ,0
1 0 1 ,0
1 4 0 ,0
2 4 ,2
0 ,0
2 7 ,6
2 8 ,1
4 0 ,2
6 7 ,5
8 6 ,2
6 7 ,3
5 6 ,5
2 5 ,5
1 0 ,3
2 ,5
3 ,0
3 ,5
4 ,0
3 ,5
3 ,5
3 ,0
3 ,0
2 ,5
3 ,0
4 ,0
C r is is E c o n o m ie s
O th e r E M E s
O f w h ic h C h in a
4 ,6
3 ,8
1 .6
2 7 ,1
1 6 ,0
1 0 .2
1 3 5 ,4
3 1 ,1
1 3 .0
3 9 ,4
3 2 ,2
3 4 .0
3 ,2
2 ,8
1 .5
C o n tro l G ro u p
7 ,5
1 1 ,8
5 9 ,7
6 8 ,5
3 ,3
C o u n try
N o te : O th e r E M E s in c lu d e th e P R C , I n d ia , C o lo m b ia , th e C z e c h R e p u b lic , P o la n d , S a u d i A r a b ia a n d V e n e z u e la .
T h e C o n tr o l g r o u p in c lu d e s H o n g K o n g ( C h in a ) , S in g a p o r e , T a i p e i ( C h in a ) , C h i le , S o u th A fr ic a a n d H u n g a r y .
S o u rce: C h a n-L ee 2 0 02 .
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37
z
If China opts for a flexible exchange rate
regime, it would have to build domestic
institutions that can act as credible
nominal anchors.
•Central bank independence
•Inflation targeting
•Risk management skills of its financial
institutions
•Efficient financial markets
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Some sequencing is still needed!
T a b le 1 : A R o a d m a p f o r F in a n c ia l R e f o r m
I m p le m e n t a t i o n
Issu es
T im e -F r a m e fo r
I m p le m e n t a t io n
I. R e sto r e B a n k in g
S e c to r S o lv e n c y a n d
R e d u c e B a n k in g S e c to r
R isk s
H yb rid A p p ro a c h :
C a r v in g o u t a p o r tio n
o f N P L s a n d g r o w in g
o u t th e r e s t;
c o n tin g e n t lia b ilitie s
a r e n o t fu lly
rec o g n iz ed a n d n e ed
h ig h g r o w th to
m a in ta in fis c a l
su s ta in a b ility
U n d erm in in g
s u s ta in a b le e c o n o m ic
g r o w th a n d p o s s ib le
m e d iu m -te r m fis c a l
s tr e ss
Q u ic k r e s o lu tio n o f
N P L s v ia la r g e -s c a le
o w n e r s h ip
d iv e r s ific a tio n .
S u sta in in g h ig h ,
m e d iu m -te r m g r o w th
v ia v ia b le b a n k s a n d
S O E r e s tr u c tu r in g
F isc a l co sts, m o ra l
h a z a r d w ith o u t
o w n e r s h ip c h a n g e s
a n d w ea k c o rp o ra te
g overn an ce; N P L
r e s o lu tio n w ill e n ta il
s h o r t-te r m h ig h d e b t
to G D P r a tio
B e tte r fu n c tio n in g
g overn m en t bon d
m a r k e ts a n d b e tte r
e q u ity m a r k e t fo r
p r iv a tiz a tio n ;
tra n sp a re n t b u d g et
in stitu tio n s a n d
s tr e n g th e n in g ta x
a d m in is tr a tio n
S O E o w n e r s h ip
d iv e r s ific a tio n a n d
r e s tr u c tu r in g m u s t
a c c e le r a te .
R a tio n a liz in g c e n tr a l
a n d lo c a l fis c a l
a rra n g m en ts;
w id e n in g ta x b a s e .
S ta r t n o w a n d
a c c e le r a te e x istin g
p r o g r a m s to m a in ta in
fis c a l s u s ta in a b ility in
th e m e d iu m te r m .
II. C h a n g e In c e n tiv e
S tr u c tu r e s
A tte m p t to b u ild a n
in c e n tiv e str u c tu r e
w ith o u t c le a r p r o p e r ty
r ig h ts
S evere agen cy
p r o b le m s; in c r e a s e d
s ta te a s s e ts s tr ip p in g
a n d r e la te d c o r r u p tio n
C le a r p r o p e r ty r ig h ts
th r o u g h o w n e r sh ip
d iv e r s ific a tio n
P o ss ib ility o f
tr a n s itio n a l
u n em p lo ym e n t a n d
s o c ia l d islo c a tio n
E ffe c tiv e le g a l s y s te m
to e n fo r c e p r o p e r ty
r ig h ts
C o n v e r tin g p r iv a te
s a v in g s in to
o w n e r sh ip c la im s v ia
s h a r e h o ld in g s
S ta r t n o w a s it m a y
ta k e d e c a d e s
III. In d e p e n d e n c e o f th e
C e n tr a l B a n k a n d
S u p e r v is o r y A g e n c ie s
U n d e r c o n tr o l o f th e
S ta te C o u n c il;
m u ltip le s u p e r v is o r y
a g e n c i e s s u b je c t t o
p o litic a l in te r fe r e n c e s
P e r p e tu a te s
govern m en t
in te fe r e n c e a n d p o o r
s ta n d a r d s ; p o litic iz e d
e x it p o lic ie s
F u ll in d e p e n d e n c e
D iffic u ltie s in
c o o r d in a tin g fis c a l
a n d m o n e ta r y p o lic y
a n d a c c o u n ta b ilitie s
C o m p eten t
te c h n o c r a ts a n d
reg u la to rs;
e n fo r c e m e n t o f r u le s b a s e d s u p e r v is io n ;
b e tte r a c c o u n ta n c y ,
tra n sp a re n cy a n d
d is c lo s u r e s ta n d a r d s
A p p o in t in d e p e n d e n t
c e n tr a l b a n k e r a n d
reg u la to rs a n d
im p r o v e th e c o u r t
s y s te m ; d e v e lo p
in d ir e c t m o n e ta r y
p o lic y in s tr u m e n t v ia
b e tte r in te r b a n k a n d
m on ey m ark et
S h o r t to M e d iu m
te r m
IV . S ta g e d In te r e st R a te
L ib e r a liz a tio n
A d m in s tr a tiv e ly
c o n tr o lle d in te r e s t
r a te s
Im p r o p e r p r ic in g o f
risk s
P h a se d in te r e s t r a te
d e r e g u la tio n w ith a
b a la n c e o n
c o m p e titio n a n d
b a n k s ' fr a n c h is e v a lu e
T ip s
s tr u c
o w in
y ie ld
F u n c tio n in g in te r ban k an d m on ey
m a r k e ts; c a p a c ity to
a c tiv e ly m o n ito r
c re d it g ro w th to
s p e c u la tiv e s e c to r s
L e n d in g r a te s fir s t
fo llo w e d b y d e p o s it
r a te s
S ta r t n o w
V . N e w D o m e s tic a n d
F o r e ig n B a n k E n tr y
A d m in is tr a tiv e
r e q u ir e m e n ts fo r e n tr y
a n d r e str ic te d fo r e ig n
e n tr y
M a in ta in o lig o p o ly
r e n ts , b u t lim it
fin a n c ia l in n o v a tio n
a n d c o m p e titio n
E n c o u r a g e e n tr y o f
r e p u ta b le fo r e ig n
fin a n c ia l in s titu tio n s
th r o u g h jo in t v e n t u r e s
or M & A , as a part of
W T O c o m m itm e n t
W e a k e r c o m p e titio n
m a in ta in s d o m e s tic
m o n o p o ly p o w e r ; d e
fa c to a c c e le r a tio n o f
K A O v ia r e la b e lin g
o f c a p ita l flo w s
L e v e l p la y in g fie ld
fo r r e g u la to r y c o n tr o l;
" F it a n d p r o p e r "
c r ite r ia fo r e n tr y .
H ig h e r p r u d e n tia l
o v ersig h t a n d
tra n sp a re n cy
s ta n d a r d s ; m o n ito r
n e t p o sitio n s o f b a n k s
a n d b e a w a r e o f o ffb a la n c e sh ee t risk s
E n c o u r a g e fo r e ig n
fin a n c ia l in s titu tio n s
e n tr y to im p r o v e
in fo r m a tio n
p r o c e s s in g a n d
e n h a n c e risk
m a n a g e m e n t s k ills ;
N a tio n a l tr e a tm e n t fo r
fo r e ig n b a n k s
S ta r t n o w
V I. O p e n th e C a p ita l
A ccou n t
R e la tiv e ly r e s tr ic te d
A p p r o p r ia te in th e
s h o r t r u n b u t w ith
d isto r tin g c a p ita l
co sts
R isk -b a sed
s e q u e n c in g
C u rren cy an d
m a tu r ity m is m a tc h e s
B e tte r lo n g -te r m d e b t
m a r k e ts a n d c a p a c ity
to m o n ito r s h o r t-te r m
c a p ita l in flo w s
F D I, tr a d e c r e d its ,
fo llo w e d b y p o r tfo lio
in v e s tm e n t a n d b a n k
lo a n s d e p e n d in g o n
in stitu tio n a l c a p a c ity ;
b e a w a r e o f la b e lin g
o f c a p ita l flo w s v ia
d e r iv a tiv e s
M e d iu m
V
E
A
R
A
P e g g e d to th e U S
d o lla r .
C h in a h a s s ig n e d
b ila te r a l s w a p
a r r a n g e m e n ts w ith
k e y c o u n tr ie s in th e
r e g io n b a s e d o n th e
C h ia n g -M a i
In itia tiv e s
Illu s io n o f F X
g u a r a n te e d isc o u r a g e s
h e d g in g p r a c tic e s
C urren cy B asket
S y s te m a n d
fo r m a liz e d
m u ltila te r a l m o n e ta r y
arran g em en t
G r e a te r v o la tility;
m an ag em en t of
e x p e c ta tio n ;
D iffic u ltie s o f
m o n ito r in g a n d m o r a l
h azard
G r e a te r tr a n s p a r e n c y
a n d c o n s is te n c y o f
e c o n o m ic p o lic y ;
R e g io n a l m o n e ta r y
arran gem en t
U se D o lla r /Y e n /E u r o
a s k ey ba sk et
c u r r e n c ie s;
A c tiv e ly p a r tic ip a te in
r e g io n a l m o n e ta r y
c o o p e r a tio n
S h o r t- te r m fo r th e
e x c h a n g e r a te r e g im e
a n d m e d iu m te r m fo r
th e fo r m a l r e g io n a l
le n d e r o f la s t r e s o r t
a r r a n g e m e n t.
P o li c y G o a ls
II. M o r e F le x ib le
x c h a n g e R a te a n d
c tiv e P a r tic ip a tio n in
e g io n a l F in a n c ia l
rran gem en t
E x is tin g S tr a te g y
P r o b le m s a n d
L im ita tio n s
P r o p o s a ls
I n stit u tio n a l
R e q u ir e m e n ts
P o s s ib le N e w
R is k s
m a tu r ity
tu r e to sh o r t te r m
g to d isto r te d
curve
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term
z
Sequencing steps
1. Resolving the banking sector risks
2. Change domestic incentive system
3. Building credible domestic institutions
4. Staged interest rate liberalization
5. Allow domestic and foreign entry
6. Staged capital account liberalization
7. Flexible exchange rate regime and
participating the regional financial
arrangement
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What is an optimal exchange rate regime for China?
• The current exchange rate regime is not bad as long as
capital control can be strengthened
• China’s capital control is still likely to remain for some
time
• But flexible exchange rate regime is inconsistent with
capital controls
• BBC (band, basket peg, and crawling peg) are
susceptible to big shocks, stabilizing speculation, and
furnishing credible nominal anchors.
• Managed floating with close monitoring of currency
mismatches? (Goldstein, 2002, Bordo, 2003)
• It remains a theoretical and empirical issue!
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V. China’s Role in the World Economic Imbalance
China is not yet a world locomotive. A drop of
Chinese growth has limited impact on the rest
of world (WEO, 2004).
E x p o r ts o f S e le c te d C o u n tr ie s to C h in a
(I n p e r c e n t o f th e ir to ta l e x p o r ts )
Jap an
K o rea
S in g a p o r e
In d o n e s ia
M a la y sia
P h i l ip p i n e s
T h a ila n d
In d ia
2000
2002
2003
6 .3
1 0 .7
3 .9
4 .5
3 .1
1 .7
4 .1
1 .8
9 .6
1 4 .7
5 .5
5 .1
5 .6
3 .9
5 .2
4 .1
1 3 .6
2 0 .5
7 .0
7 .4
1 0 .8
1 2 .0
7 .1
6 .4
S o u r c e : I M F D i r e c t io n o f T r a d e S t a t i s t i c s .
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z
China’s policy priorities are still within its
domestic sector and its continued structural
reform will make it normal economy.
• Reduce the urban-rural inequality and speed up
urbanization process.
• Unify its domestic market and remove non-tariff barriers
• Reduce the tyranny of distance to facilitate market
integration
• Need domestic long-term bond market for these funding
needs and foreign capital!
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