HONG KONG ANALYSTS CREDIT CHINESE STIMULUS FOR

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 001829

SIPDIS
SENSITIVE

STATE FOR EAP/CM AND EEB/IFD/OMA, TREASURY FOR OASIA,
BEIJING FOR DOLLAR

E.O. 12958: DECL: 09/25/2034
TAGS: EFIN ECON HK CH
SUBJECT: HONG KONG ANALYSTS CREDIT CHINESE STIMULUS FOR
ASIA'S RECOVERY

Classified By: Economic and Political Chief Martin Murphy, Reason 1.4 b
/d


1. (C) Summary: Hong Kong economic analysts give China full
credit for Asia's rebounding economies. The region's
financial systems were generally well capitalized and less
exposed to toxic assets, making the rebound that much
quicker, but with the exception of China, national fiscal
stimulus packages were ineffective at best. Analysts believe
we are now in the midst of a cyclical increase that should
extend through 2010, as inventories are rebuilt and
confidence returns to the region. Massive lending by Chinese
banks is certain to lead to a rash of non-performing loans in
2012-13, but analysts believe Chinese leaders see this as a
necessary cost and differ on just how big a threat these NPLs
will be. End Summary


2. (C) Comment: Locally-based analysts are strongly
optimistic about Asian, and particularly Chinese, economic
prospects over the next several years. They see little risk
to China's rapid loan growth and credit the speed of China's
stimulus package announcement with boosting confidence across
the region. While long-term structural problems haven't
disappeared and no one is suggesting China will replace U.S.
demand or economic leadership, observers in Hong Kong believe
China has played the crisis just right so far. End Comment


3. (U) JP Morgan's Head of China Research Qian Wang, Royal
Bank of Scotland (RBS) Economist Ben Simpfendorfer, Standard
Chartered Regional Economist Kelvin Lau, HSBC Regional
Foreign Exchange Strategist Daniel Hui, UBS Chief Asia
Economist Duncan Woolridge, Hong Kong Monetary Authority
(HKMA) Head of Research Lillian Cheung, and Credit Suisse
Managing Director Vincent Chan shared their views on Asian
governments policy responses to the financial turmoil of the
past year and prospects for future growth in the region with
Consulate Economic officers September 21-22.

======================
Recovery Made in China
======================


4. (C) Hong Kong analysts agreed that Asian economies are
emerging from the global slowdown and China deserves all the
credit for Asia's relatively rapid recovery. The crumpling
of U.S. and European demand for Asian exports, coupled with
the lack of access to credit following the collapse of Lehman
Bros. hit regional economies hard. Hong Kong saw trade
volumes drop 20-30 percent, other regional economies saw
similar downturns. Yet the relative soundness of Asian
financial systems and their limited exposure to toxic assets
is allowing a rapid rebound, said HKMA's Cheung. RBS,
Simpfendorfer praised China's response as quick and credible,
essential to boost confidence in China and the region.


5. (C) Analysts differ, however, over which part of the
Chinese response deserves the most credit for the improved
sentiment in the region. JP Morgan's Wang noted that China's
fiscal stimulus package benefited from a large number of
"shovel-ready" projects already on municipal and provincial
drawing-boards. Quickly getting those projects approved and
people working was crucial to restoring confidence. UBS's
Woolridge disagreed, pointing to the unprecedented level of
loan growth in the first half of 2009 as the key driver of
recovery in China and the region. Credit Suisse's Chan
suggested there was little difference between China's fiscal
and monetary responses to the global financial crisis. High
loan growth is tied directly and indirectly to local
government borrowing to fund infrastructure development and
other fiscal stimulus programs, said Chan. With exports
still far below 2008 levels and domestic consumption unable
to fill the gap, fixed asset investment driven by government
borrowing is driving the Chinese economy.

======================================
Government Spending Can't Last Forever
======================================


6. (C) Whether they call it fiscal stimulus, loose monetary
policy or some combination of the two, analysts believe that
Chinese government-backed spending, particularly fixed asset
investment, will continue to drive Chinese economic growth
over the next several quarters. Local governments are
enthusiastic supporters of this policy, while the Central
government is starting to worry, said Chan. Government
spending measures help now, but will become increasingly less

HONG KONG 00001829 002 OF 003


effective over time, warned Standard Chartered's Lau.
Exports will increase in the near term as restocking takes
place, but are likely to fall back again later in 2010 as
U.S. demand remains low. Chan said most Chinese technocrats
believe over-reliance on exports will squeeze Chinese growth
prospects, but that the shift to increased domestic
consumption will be a long process.


7. (C) The problem with the Chinese stimulus package, said
Simpfendorfer, is that it is too narrow. China's economy
needs structural reforms to open new sectors. Chinese
manufacturing is now a mature sector with less obvious
opportunities for rapid growth, he said. Exports to the rest
of Asia may increase, but can't compensate for lower Western
demand. Instead, China needs to open up the services sector,
including logistics and marketing, and improve contract and
intellectual property laws. Infrastructure development
without structural reforms will not have broad-based economic
benefits, he argued.

============================================
Regional Economies Stimulus Depends on China
============================================


8. (C) Fiscal stimulus programs in other parts of the region
were uniformly dismissed by Hong Kong-based analysts as
ineffective at best and harmful in some cases. Taiwan's
voucher program to increase domestic consumption was targeted
too widely and merely served to substitute for spending that
would have taken place in any case, said Wang. It achieved
nothing but widening the hole in the government's budget, she
said. Hong Kong,s waivers, rebates and loan guarantees
helped cushion the economic blow for low income residents and
Small and Medium Enterprises (SMEs),but domestic consumption
is still weak and infrastructure plans still haven't gotten
off the ground, said Lau. Simpfendorfer agreed, noting that
infrastructure projects in non-command economies take too
long and most Asian tax systems do nothing to facilitate
consumption. Stimulus programs in many regional economies
were "worth less than nothing," he said.


9. (C) The Chinese stimulus is boosting demand for
commodities from Southeast Asia, components from Taiwan and
Korea, and demand for services from Hong Kong, said Lau.
UBS's Woolridge believes Asian manufacturers are finally
beginning to benefit from record low inventory levels, as
orders are finally beginning to pick up. Increasing
production requires additional labor, and consumer confidence
is rising as unemployment falls. He expects the recovery in
Asia will gain steam over the next several quarters.
However, massive Chinese loan growth has already created
asset bubbles in housing and equities. In Hong Kong, RMB
liquidity and international investors eager to tap into
Chinese growth opportunities are fueling rising asset prices.
HKMA's Cheung said that with global credit markets still
relatively clogged, Hong Kong,s liquid markets and 100%
deposit guarantee are attracting significant hot money flows
that are boosting local property and stock markets. In the
near term, this is creating a virtuous cycle of increasing
wealth and confidence, she said.

=======================
NPLs Tomorrow's Problem
=======================


10. (C) Analysts agree that rapidly expanding loan growth in
the first half of 2009 has fueled the regions, recovery, but
differ on whether inevitable increases in non-performing
loans are worrying. Woolridge acknowledged that NPLs and
opportunities for corruption will increase, but argued that
it is easier for Chinese policymakers to flood the system
with liquidity to boost growth now and clean up NPLs later
than to face a serious economic slowdown. HSBC's Hui echoed
that view, noting that policymakers should be worried, but
are more concerned about maintaining growth and are willing
to "kick the (NPL) can down the road." Chan noted that local
government debt as a percentage of GDP will increase from 5
percent in 2004 to about 30 percent in 2010. This is not too
high, but could be a problem in some poorer provinces, he
said. JP Morgan's Wang suggested that the most senior levels
of the Chinese leadership may by motivated by different
goals. Premier Wen is most concerned about social stability
and protecting his legacy, said Wang, while the next
generation of senior leaders does not want to face a serious
NPL problem as soon as they take the reins in 2012. She
predicted that the People's Bank of China (PBOC) would rely

HONG KONG 00001829 003 OF 003


on its ability to institute micro-level controls on lending
to certain regions and sectors to minimize future NPLs.
MARUT