Identifier
Created
Classification
Origin
06HONGKONG1921
2006-05-10 00:20:00
CONFIDENTIAL
Consulate Hong Kong
Cable title:  

CHINA'S ECONOMIC POLICIES THE FOCUS OF FINANCIAL

Tags:  ECON EFIN PREL CH HK 
pdf how-to read a cable
VZCZCXRO8958
OO RUEHCN RUEHGH
DE RUEHHK #1921/01 1300020
ZNY CCCCC ZZH
O 100020Z MAY 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6571
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASH DC
C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 001921 

SIPDIS

SIPDIS

STATE FOR EAP/CM AND EB
STATE PASS USTR
USDOC FOR DAS LEVINE, ITA/OCEA MCQUEEN AND CELICO
TREASURY FOR KOEPKE
NSC FOR WILDER

E.O. 12958: DECL: 05/09/2031
TAGS: ECON EFIN PREL CH HK
SUBJECT: CHINA'S ECONOMIC POLICIES THE FOCUS OF FINANCIAL
ATTACHE LOEVINGER'S HONG KONG MEETINGS

Classified By: E/P Chief Simon Schuchat. Reason: 1.4 (b,d)


SUMMARY
-------

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 001921

SIPDIS

SIPDIS

STATE FOR EAP/CM AND EB
STATE PASS USTR
USDOC FOR DAS LEVINE, ITA/OCEA MCQUEEN AND CELICO
TREASURY FOR KOEPKE
NSC FOR WILDER

E.O. 12958: DECL: 05/09/2031
TAGS: ECON EFIN PREL CH HK
SUBJECT: CHINA'S ECONOMIC POLICIES THE FOCUS OF FINANCIAL
ATTACHE LOEVINGER'S HONG KONG MEETINGS

Classified By: E/P Chief Simon Schuchat. Reason: 1.4 (b,d)


SUMMARY
--------------


1. (C) Hong Kong-based investment bank analysts and
economists generally welcome China's recent economic
tightening measures, and some believe that recent and
significant appreciation of Asian currencies may lead to
quicker upward movements in the value of the renminbi (RMB).
They used the occasion of meetings held May 2-5 with Embassy
Beijing's newly-arrived Financial Attache David Loevinger to
suggest that U.S. efforts to get China to move on currency
appreciation and capital account liberalization are most
effective when presented via private diplomacy and in the
context of the mainland's own long-term economic interests.
Loevinger also discussed the apparent near-intractability of
China's high rate of precautionary savings and heard several
analyses of how uncertainty about future needs for education,
health care, housing, and retirement drives consumers to
minimize their day-to-day spending. END SUMMARY

VISIT DETAILS AND MEETINGS
--------------


2. (U) Embassy Beijing's newly-arrived U.S. Treasury
Financial Attache David Loevinger held meetings in Hong Kong
May 2-5 with investment bank analysts, academics, economists,
and Hong Kong Government officials, including:

-- William Ryback, Deputy Chief Executive, Hong Kong
Monetary Authority
-- Guonan Ma, Senior Economist
Bank of International Settlements
-- Jonathan Anderson, Managing Director, UBS
-- Hong Liang, Executive Director, Asia-Pacific Research,
Goldman Sachs
-- Jun Ma, Managing Director, Deutsche Bank
-- Grace Ng, Managing Director, JP Morgan
-- Simon Ogus, Chairman, Dismal Science Group (DSG)
-- Hongbin Qu, Senior China Economist HSBC
-- Jim Walker, China Economist, CLSA
-- Geng Xiao, Associate Professor of Finance, Hong Kong
University
-- Andy Xie, Managing Director, Morgan Stanley



BROADER MEANING IN RECENT INTEREST RATE HIKE
--------------


3. (SBU) China raised lending interest rates by 0.27 percent
to 5.85 percent on April 27. Our interlocutors downplayed
the economic significance of the hike itself but saw broad
significance in the move. UBS's Anderson believes the
increase signals to banks that the People's Bank of China
(PBC) is getting serious about reining in recent credit
growth, a danger in particular for the property and
construction sectors, and may take administrative action to
follow it up. That said, the small magnitude implies that
the PBC is not concerned overall with economic overheating.


4. (C) CLSA's Walker disagrees with that interpretation. He
observed that the increase has come notably early in the
current cycle of discussion about overheating and suspects
that monetary authorities are acting quickly because they
expect rising commodity prices and wage rates to be reflected
shortly in inflation trends. Walker, referring to recent
conversations with mainland think tank economists, suggested
that PRC economic policy officials are likely heeding a
lesson of history: once inflation is embedded in China's
economy, it is hard to stop without a shock to the system.
In line with Walker's views, HKMA's Ryback praised the PBC
for its early intervention, commenting that it is better to
brake now than later. He noted that Hong Kong's benchmark
stock index for China listings had rebounded quickly after
the shock of the news; this suggests a broad acceptance that
mainland officials are acting appropriately to preserve
better prospects for the long run.

TRICKY CURRENCY POLICY ENVIRONMENT
--------------


HONG KONG 00001921 002 OF 003



5. (C) The China watchers listed changing conditions that
support a more rapid rise in the RMB, but they made clear
that appreciation has been held in check in part because of
conservative voices in the Chinese government (e.g., NDRC,
Commerce) and sensitivities about economic relations with the
U.S. They observed that the undervalued RMB is drawing in
excess foreign currency, complicating needed efforts to
restrain credit growth. Goldman's Liang said that
appreciation of other Asian currencies this year increases
the likelihood of the RMB rising more quickly. (Note: As of
May 8, the Korean Won was up nearly 9 percent, the Singapore
dollar 6 percent, the Japanese yen 5 percent. End Note.)
This trend not only reduces the trade-weighted value of the
RMB but also creates the unwelcome prospect of trade tensions
between China and Asian trade partners -- and besides, China
is by nature a "follower" in taking action on regional
financial challenges. JP Morgan's Ng suggested that the RMB
might have moved more on the occasion of Hu's visit to
Washington had the Chinese side not concluded that U.S.
late-game emphasis on IPR issues implied that a currency
deliverable was not necessary. Like Liang, she focused on
the trade-weighted value decline of the RMB and concluded
that the down-trend of the USD among other currencies offers
China a very good opportunity for letting significant
appreciation go forward.


6. (C) Liang and Ng separately emphasized the importance that
Japan's experience with currency appreciation plays in the
minds of NDRC economists and others in the economic
bureaucracies. While there is a debate to be had about just
what caused Japan's lengthy stagnation in the 1990s, Chinese
policy makers are clearly wary of how the 1985 Plaza Accord,
which led to yen appreciation, is often cited in the chain of
events that made it difficult for Japan to deal with a
recession some years later. Ng said that China sees itself
as a much poorer country than Japan was in 1985 and therefore
less capable of dealing with any resulting shocks from a RMB
rise.


7. (C) HKU's Geng emphasized the role that anxieties about
inflation and deflation play for China in crafting RMB policy
approaches. He lamented that China does not have a higher
rate of inflation -- perhaps 5 percent would be desirable --
as this would be typical of an economy experiencing such high
levels of growth and transition. Since productivity is
rising rapidly, it is only natural that the prices of
non-tradable goods would rise relative to tradables, i.e.,
changes in relative prices should be expected. The public,
however, has strong negative associations with inflation
based on experiences in the 1970's and 1990's. Meanwhile,
overcapacity in sectors like steel and cement leaves policy
makers fearful of igniting deflation through a currency hike.
Were the public accepting of moderate inflation and were
this to already exist in the economy, then the pondered
effect of a rising RMB would merely be a decrease in the
inflation rate rather than the prospect of slipping into
deflation.

SUGGESTIONS FOR U.S. DIPLOMACY
--------------


8. (C) We received numerous comments that the U.S. messages
to China on currency policy and financial liberalization
should be delivered privately and should be packaged with
emphasis on why taking various steps is in the interest of
the mainland itself. "Bullying" that is done in the context
of U.S. domestic political debates is counter-productive, in
the view of several of the China watchers we met with.
Morgan Stanley's Andy Xie said the U.S. will continue to be
challenged by a historical Chinese attitude that dangers
ahead are best approached by "muddling through." In his
view, the U.S. should propose packages of measures that taken
together would not amount to "shock therapy" for a society
that is already very tense amidst economic transition.
Goldman's Liang said the U.S. needs to bolster its own
credibility by showing that it will reduce its fiscal
deficit. In her view, China's leadership sees the unwinding
of global imbalances as a question of burden sharing.
China's approach with the U.S. is actually an act of
bargaining over who will feel what economic pain. JP
Morgan's Ng emphasized the "face" aspects of public
criticism, cautioning that the most likely factor in whether
RMB appreciation is slowed from what it would be otherwise is

HONG KONG 00001921 003 OF 003


America's public posture on the issue. BIS's Ma said the
U.S. should note to China how currency liberalization would
lift China's capacity to manage economic shocks and crises.

PRECAUTIONARY SAVINGS
--------------


9. (SBU) There was little optimism on the issue of
precautionary savings, i.e., the tendency of Chinese
consumers to save a high proportion of income in response to
concerns about future requirements with regard to education,
health care, housing, and retirement. Morgan Stanley's Xie
called on the PRC to boost consumer spending power with bond
issuances aimed at rural residents and through distribution
of proceeds from the sale of state assets. A major challenge
is the erratic nature of future costs, e.g., costs for
medical treatment are unclear or inflated by corruption while
education fees are erratic in their composition and rising
quickly. HSBC's Qu noted that much of what is saved is for
specific goals (e.g., housing),so efforts to raise returns
on savings should help -- such as recently announced
provisions to allow for limited individual investment in
assets abroad. BIS's Ma suggested that the savings issue is
aggravated by the one-child policy -- working parents are
concerned at the prospect of having only one child to assist
them in retirement -- a factor that is not going to go away
any time soon.
Cunningham