Identifier
Created
Classification
Origin
07BEIJING808
2007-02-02 06:17:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Beijing
Cable title:  

BANK OF JAPAN REPRESENTATIVE'S CONCERNS ABOUT CHINA'S

Tags:  ECON EFIN EAGR WTRO CH JP 
pdf how-to read a cable
VZCZCXRO5856
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0808/01 0330617
ZNR UUUUU ZZH
P 020617Z FEB 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 4438
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEHKO/AMEMBASSY TOKYO 1141
UNCLAS SECTION 01 OF 02 BEIJING 000808 

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM
TREASURY FOR OASIA -- DOHNER, HARSAAGER, CUSHMAN
USDOC FOR 4420

E.O. 12958: N/A
TAGS: ECON EFIN EAGR WTRO CH JP
SUBJECT: BANK OF JAPAN REPRESENTATIVE'S CONCERNS ABOUT CHINA'S
CURRENCY AND MONETARY POLICY CHALLENGES


SUMMARY
-------

UNCLAS SECTION 01 OF 02 BEIJING 000808

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM
TREASURY FOR OASIA -- DOHNER, HARSAAGER, CUSHMAN
USDOC FOR 4420

E.O. 12958: N/A
TAGS: ECON EFIN EAGR WTRO CH JP
SUBJECT: BANK OF JAPAN REPRESENTATIVE'S CONCERNS ABOUT CHINA'S
CURRENCY AND MONETARY POLICY CHALLENGES


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


1. (SBU) The Bank of Japan (BOJ) Chief Representative to China,
Kiyoyuki Seguchi, said that BOJ is concerned that China's large
balance of payments surplus and rigid exchange rate are contributing
to excess liquidity, over-investment, and asset bubbles in real
estate and stocks, increasing the risk of a boom/bust cycle. To
maintain financial and price stability, the People's Bank of China
(PBOC) might be forced to slam on the brakes, sharply limiting
lending and making it difficult for borrowers to roll over debt.
China should avoid such a scenario by tightening monetary policy
now. Seguchi said that the PBOC understands the need for renminbi
(RMB) appreciation but is politically constrained by concerns about
the adverse impact on: (1) agricultural competitiveness, given the
rapid rise in imports due to implementation ofChina's WTO
commitments; and (2) processing sctor (export assmbly) jobs. He
said that a 10-20 percent short-term RMB appreciation would cause
numerous marginal low-end producers to close factories in China,
noting that the sectors they represent (e.g., textiles) are
particularly labor intensive. END SUMMARY

VIEWS ON CURRENCY AND MONETARY POLICY
--------------


2. (SBU) Seguchi recently told Finatt and Econoff that the BOJ's
views on renminbi (RMB) valuation are very close to those of the
United States Treasury. He said that the BOJ is concerned that a
large balance of payments surplus and a rigid exchange rate are
contributing to excess liquidity, over-investment, and asset bubbles
in real estate and stocks, increasing the risk of a boom/bust cycle.
To maintain financial and price stability, the PBOC might be forced
to slam on the brakes, sharply limiting lending and making it
difficult for borrowers to roll over debt.


3. (SBU) In Seguchi's view, China should avoid such a scenario by
tightening monetary policy now. Even though corporate investment is
increasingly financed through retained earnings, there remains a

relatively tight link between credit and investment growth, so
constraining the former will constrain the latter.

WHAT CHINA SHOULD DO
--------------


4. (SBU) Seguchi said that the PBOC understands the need for RMB
appreciation but is politically constrained by concerns about the
adverse impact on: (1) agricultural competitiveness, given the rapid
rise in imports due to implementation of China's WTO commitments;
and (2) processing (export assembly) jobs. Seguchi said that a
10-20 percent short-term RMB appreciation would cause numerous
marginal low-end producers to close factories in China, and the
sectors they represent (e.g., textiles) are particularly labor
intensive.


5. (SBU) As for interest rates, Seguchi believes that Chinese
monetary officials are reluctant to raise deposit rates because of
their concern that banks' inability to assess and manage credit risk
would continue to lead to a high level of non-performing loans. As
a result, monetary authorities want to maintain a large
intermediation spread to generate sufficient income to provision for
bad loans.

JAPANESE INVESTMENT IN CHINESE BANKS
--------------


6. (SBU) Seguchi observed that Japanese banks still remain cautious
about investing in Chinese banks given the large losses they
incurred investing in local government international trade and
investment corporations (ITICs) in previous years that subsequently
went bankrupt. The "China hands" who populated Japan's banks at
that time are now key decision makers, tarnished by this experience
of learning the hard way that government backing could not be taken
for granted.

LEARNING FROM JAPAN'S EXPERIENCE
--------------


7. (SBU) Finatt explained how Chinese officials argue that the
lesson they draw from Japan's experience in the 1980s is not to
concede to foreign pressure to let the exchange rate appreciate
since, in these officials' views, this led to a decade of deflation
and ultimately had little impact on external imbalances. Seguchi
responded that rather than avoiding Japan's mistakes, China risks
repeating them. With an open economy, China is unlikely to

BEIJING 00000808 002 OF 002


experience high inflation in goods from an undervalued currency and
excessively loose monetary policy, but will experience asset bubbles
just like Japan. Seguchi said that he has communicated to the PBOC
the importance of understanding Japan's "failure" in the 1980s,
i.e., Japan over-estimated the impact of currency appreciation on
monetary conditions, thereby easing monetary policy too much,
leading to asset bubbles and their subsequent bust and the "lost
decade" of the 1990s.

REACHING OUT
--------------


8. (SBU) Finatt urged BOJ officials (both current and former) to
broaden channels for explaining the lessons of Japan's experience to
China, since they would be the most credible interlocutors on this
issue. Seguchi responded that two officials might be particularly
effective: (1) BOJ Deputy Governor Horii, and (2) Yasuhisa Shiozaki
in the Cabinet Office. Seguchi subsequently spoke with Horii who
suggested that he and Treasury Under Secretary Adams discuss this
before Horii comes to China later in the year.

RANDT