Anoop Singh: Rebalancing Growth in China

2015-12-01 IMI

Anoop Singh:Managing Director and Head of Regulatory Affairs, Asia Pacific for JP Morgan, Former Director of IMF Asian and Pacific Department. The Chinese economy has achieved a remarkable transformation over the span of three decades to becoming close to the world’s largest economy -Over 380 million jobs have been created and around 500 million people have been lifted out of poverty. -This great achievement reflects years of reforms to open up the Chinese economy and make it more market-oriented. -In the last decade, WTO membership in 2001 helped China move quickly past Japan, the United States, and Germany to become by 2008 to become the world leading exporter. -This has allowed China to better exploit its comparative advantages and benefit from the economies of scale afforded by global markets. -In 2011, China became the engine of global final demand, contributing more to global consumption growth than any other country -Looking ahead, the Third Plenum reforms aim at making China a global player in financial integration and capital account liberalization, uplifting the trends towards an international renminbi. Lets look where this has taken the renminbi. Clearly, in parallel, the internationalization of the RMB is advancing. In recent years, cross-border settlement transactions have grown rapidly, investment vehicles denominated in RMB have expanded, and the People’s Bank of China has established a network of bilateral local currency swap lines with other central banks.[ Swap facilities have been established with a large number of central banks across the globe, including the central banks of Australia, Brazil, Malaysia, South Korea, Pakistan, Turkey, and the ECB. ]Reflecting the growing cross-border use of RMB, RMB clearing banks have been set up in a number of financial centers. What is the outlook? The economy’s size and large presence in world markets today mean that this outward growth strategy is approaching high levels by historical standards. Is there the risk that growth could run into natural limits? There are clearly multiple aspects to rebalancing China’s growth model to avoid these limits--away from exports and investment and towards private consumption as the Third Plenum clearly recognized. In my remarks today, I want to focus on three key inter-related reforms that will help rebalance the Chinese economy, sustain the growth momentum,and reinforce the trend towards a more international renminbi: exchange system reform, financial liberalization,and capital account opening. These are among the cornerstones of reforms to promote a better allocation of resources and rebalance the economy towards consumption. They need to be carefully timed and sequenced given their interrelationship. Exchange system reform While steps have successively been taken, and the current account surplus has significantly been reduced, it is well recognized thatfurther exchange system reforms are needed to help deepen progress in areas that would promote economic rebalancing: -The further large increase of international reserves last year has now taken reserves close to US$4 trillion, well above levels needed for precautionary purposes. -China continues to experience a significant need to absorb liquidity from foreign currency intervention that constrains the ability to move ahead with financial liberalization. -The REER has appreciated in real effective terms by about 6 percent in 2012 and 2103, but from a longer term perspective, the yuan is in real effective terms close to where it was in the late 1990s despite significantly higher productivity than China’s trading partners since then. -While progress has been made in exchange system reform, including doubling the renminbi’s daily trading band against the U.S. dollar in the interbank foreign exchange market to 2 percent,it is probably premature to conclude that the yuan has reached a point of genuine two-way flexibility, which is also a prerequisite for the desired opening of the capital account. -Once the currency market is more balanced and there are two-way movements in the exchange rate, this would lessen the need for monetary tools to be geared towards sterilizing foreign currency inflows and managing the currency. -Overall, the evidence still suggests that that the exchange system continues to reduce the capability of running a more proactive and independent monetary policy.

Financial system Next, let’s focus on the implications for financial liberalization, which is a key objective of the authorities. Among the lessons from international experience is that liberalizing the financial sector in an environment with excess liquidity risks raising bubbles and other imbalances in asset and goods markets that could translate into greater macroeconomic volatility.Lets discuss whether distortions in domestic relative prices remain headwinds to the government’s efforts to raise household income and to develop other domestic sectors. By various cross-country measures, the cost of capital appears low in China that has tiled the economy toward capital-intensive production. Recent studies have shown that the real cost of capital—defined as a weighted average of the real cost of bank loans, bonds, and equity—faced by Chinese listed firms is below the global average. Capital looks especially cheap when compared to its high productivity in China. In particular, country-specific estimates of the marginal product of reproducible capital (i.e., capital adjusted for land) show that the real rate of return on investment in china is much higher than real loan rates, with the discrepancy larger than in many economies. This follows from the continuing widespread implicit financial guarantees that distort the pricing of risk and the allocation of resources. In addition, the growth of shadow banking in China, further underscores the criticality of moving ahead with financial sector reforms that will allow market linked policy interest rates to be established.With lending rates now liberalized, key measures include further deposit interest rate liberalization, stepped-up supervision and regulation of the financial system (including of shadow banking), overhaul of the system of resolving financial institutions, and the introduction of deposit insurance.Higher domestic interest rates would better price capital and allow its more efficient allocation, while promoting financial intermediation in a more inclusive way by providing greater returns to small depositors. Capital Account opening Although capital flows are sizable in China, exchange controls continue to apply to most capital transactions. This is understandable. Opening to international portfolio flows should occur only after the bulk of financial sector reform has been completed. In this context, the international evidence points to the clear lesson that the interconnectedness of the world’s financial markets create large risks for those economies that open themselves up to international capital flows before the distortions and misalignments in their domestic financial systems are resolved. With a strong regulatory framework in place, overseeing a financial system that offers a wide menu of financing and investment options, capital account liberalization could be advanced. Thus, in China, as the domestic financial system becomes more market based, with fewer distortions of market clearing levels of credit and interest rates, China can start dismantling its still extensive system of controls on capital flows. Indeed, capital account liberalization is among the key reforms in the Third Plenum document, and the lessons from the Shanghai Pilot Free Trade Zone will help drive broader liberalization as the other complementary reforms move ahead. China has started the process with the right sequence—focusing on reducing restrictions on more stable, long term sources of financing such as direct investment flows. As the reform process advances, China would steadily increase the QFII (Qualified Foreign Institutional Investors) and QDII (Qualified Domestic Institutional Investors) quotas to open up short-term portfolio flows. Eventually, the quotas can be dismantled altogether. Conclusions -Much progress has been made in internationalizing the RMB, and the objective is a catalyst for supporting reforms. -Exchange rate and interest rate liberalization are among the cornerstones of reform, promoting a better allocation of resources and rebalancing the economy towards consumption. PBOC’s continuing resolute steps in this direction are critical. -SOE reforms importantly complement these financial sector reforms and the authorities have commendably recently announced their next steps in this key area. -In addition, the gradual liberalization of the capital account will reinforce financial sector reform and improve the efficiency of investment. -Exchange rate liberalization, financial sector reforms, andcapital account opening need to be carefully timed and sequenced. -The trend toward a more international renminbi is a positive one and a natural direction given China’s economic importance, and will increase as these reforms are implemented. References Anoop Singh, Malhar Nabar, Papa M N'Diaye, 2013, China’s Economy in Transition: from External to Domestic Rebalancing, ISBN: 978-1-48430-393-1 (IMF)http://www.imfbookstore.org/ProdDetails.asp?ID=CETEDEA&PG=1&Type=BL Anoop Singhwith Papa N’Diaye, 2013, Rebalancing Growth in China: The Role of the Yuan in the Policy Package, in Currencies after the Crash, ed. by Sarah Eisen, ISBN-10: 0071784888 (McGraw Hill)

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Anoop Singh: Rebalancing Growth in China

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