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On March 20, 2006, Governor Zhou Xiaochuan of the People's Bank of China (PBC) spoke at the China Development Forum on exchange rate and trade balance. Later, PBC Spokesperson Li Chao was interviewed on relevant policies and related issues.
In recent years, comparative advantages reorganization that has come as a result of faster globalization, cross-border outsourcing, adjustment of supply chain is one of the reasons behind China's growing trade surplus. Could you please elaborate on this?
We believe that China's growing trade surplus is a complex issue that involves many reasons, a very important one being the escalation of cross-border outsourcing and supply chain readjustment under the globalization trend in recent years.
The so-called cross border outsourcing refers to multinational companies moving part of service or production abroad where labor cost, tax burden and other burdens are lower. As the trend of globalization gains ground, more and more MNCs have relocated production or services abroad, and included the products as part of their global supply system to readjust their supply chain. This phenomenon has evolved faster, along with IT revolution and infrastructure improvement such as transportation, making it possible to outsource those activities that were difficult to do so in the past.
One impact of cross-border outsourcing is the changing layout of competitive advantages. Further still, such change occurs with a time lag, that is, labor-intensive production activities and services are usually outsourced to developing countries like China and India. Under pressure, developed countries shift to create and produce higher-end products in an attempt to create new jobs and fresh export advantages. But, this process usually happens after a time lag, during which trade imbalances tend to expand.
A famous U.S. writer, the international affairs columnist of New York Times, Thomas Friedman described in full details the escalation of cross-border outsourcing and supply chain adjustment in The World is Flat, a book that he spent 4 years to complete. He made it clear that cross-border outsourcing and supply chain adjustment was the inevitable result of world economy moving to adapt to globalization, and pointed out that as China opened up to global market, the more attractive it was in outsourcing and the longer the supply chain, the more necessary China's competitors (developed and developing countries alike) would find it to increase their own attractiveness. For all economies in the world, cross-border outsourcing and supply chain adjustment will remove border frictions, make the world a flat one, and enhance efficiency and competitiveness. Global cooperation will be intensified amidst competition.
There is no doubt that FDI also has played a significant role in cross-border outsourcing and trade balance shift. China has become a processing trade base dominated by foreign enterprises. The supply chain is longer and longer with value added growing. FDI's production expansion and sales surge have replaced China's import. In the Chinese market, there are plenty of foreign brand products designed in foreign countries, but the bulk of it is made in China by FDI enterprises.
Governor Zhou Xiaochuan said in his remarks that various departments of the Chinese Government have already started to apply a mix of policy measures, including expanding domestic demand, lowering down saving rate, opening up the market, floating the exchange rate and increasing import, so as to improve the balance of payments.
As an important measure, how is the progress of RMB exchange rate regime reform? Will measures be taken in the future to further improve this reform?
On July 21, 2005, China reformed the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB has no longer been pegged to the US dollar. After the reform, the RMB exchange rate has become more flexible. At the spot market, the RMB exchange rate is no longer kept unchanged, but allowed to fluctuate within a daily band of ±0.3 percent around the central parity. Since the introduction of the inter-bank foreign exchange market for RMB forward trading, the FX forward rate has been completely based on market supply and demand, without any band restriction. On September 23, 2005, the daily band of the RMB spot rate against the non-US dollar foreign currencies was widened. In the meantime, the US dollar rates quoted by the foreign exchange-designated banks to their customers was widened up to 1 percent around the central rate. On January 4, 2006, OTC transactions and market makers were introduced in the inter-bank spot foreign exchange market. The formation of the central parity of RMB against the US dollar was determined by the weighted average of the prices quoted by 15 market makers consisting of both local banks and foreign banks. The degree of market determination in the formation of RMB rate has been further increased.
From July 21, 2005 to March 21, 2006, the RMB exchange rate against the US dollar appreciated accumulatively by 3.09 percent. In the past eight months, the RMB to dollar exchange rate has been moving in both upward and downward directions in a more flexible manner, reflecting exchange rate movements among major currencies and displaying the characteristics of the new regime based on market supply and demand with reference to a basket of currencies. In particular, since the introduction of market makers, the flexibility of RMB exchange rate has increased remarkably.
In order to improve the flexibility of RMB exchange rate, foreign exchange markets have to be further developed to allow the market to play a larger role in determining the RMB exchange rate. For various Chinese business and financial institutions to adapt themselves to the new RMB exchange rate regime, the foreign exchange market needs to have sufficient depth and a rich variety of products, including further growth of the foreign exchange market, improvement of the forex market system and gradual introduction of risk management instruments.
On August 2, 2005, a larger variety of participants were given access to the forward foreign exchange market, the coverage of transactions was expanded and the restrictions on trading maturities were eased; banks were allowed to quote at their discretion and to provide RMB swaps against foreign currencies. On August 8, 2005, qualified non-bank financial institutions and non-financial businesses were allowed access to the inter-bank foreign exchange spot market. RMB-foreign currency swap transactions were introduced to inter-bank foreign exchange market. On August 15, 2005, inter-bank foreign exchange forward market was officially introduced. 64 Chinese banks and foreign banks such as the Citibank have become members of the forward market so far, 50 of them are foreign banks and 5 are from the US.
Since the introduction of OTC transactions and market makers on January 4, 2006, OTC market has become the principal part of China foreign exchange markets and the market makers have become the leading players in the markets. On February 9, 2006, RMB interest rate swap was launched on pilot basis. On March 10, 2006, the China Foreign Exchange Trade System & National Inter-bank Funding Center (CFETS) and CME announced that they have entered into a multi-year agreement under which Chinese financial institutions and investors will gain access to electronic trading of CME foreign exchange and interest rate products. All these have provided support for the Chinese foreign exchange market to further integrate with the international market.
During the past eight months, Chinese government had devoted a great effort to relax foreign exchange controls, including significantly relaxing the restrictions on the enterprises' foreign exchange cash retaining ratios in their foreign exchange account under current account, raising FX purchasing ceiling of individual residents and largely simplifying the procedures, relaxing the restrictions on the use of foreign exchange by enterprises under capital account. At the next step, we will continue to adjust some of foreign exchange administration policies, and create better environment to allow market to play better role in the determination of RMB exchange rate.
In the future, China will continue to refine the reform of RMB exchange rate regime, develop foreign exchange market, increase the RMB exchange rate flexibility, and help financial institutions to develop independent pricing and risk management capabilities. Since the RMB has the room and capability to float independently upward or downward in response to market changes under the current regime, there will be no one-off exchange rate adjustment through official announcement. Rather, there will be independent floating under the current exchange rate regime according to supply and demand changes at the foreign exchange market and exchange rate movements among major international currencies.
We need to boost domestic demand in order to achieve a trade balance, what is the relationship between them?
Macroeconomics describes the duality relationship between the difference between savings and investment and the difference between exports and imports. Excess savings will result in trade surplus, and vice versa, inadequate savings will result in trade deficit.
High savings rate and high trade surplus are both seen in the Chinese economy. Therefore, exchange rate is not the only means to address trade imbalance, whilst comprehensive measures need to be taken to this end. One of important measures is to lower savings rate and boost domestic demand, consumption in particular, thereby to promote economic growth and import growth so as to improve trade balance.
What are the specific measures to expand domestic demand?
The newly issued 11th " Five-year Program" puts forward that China "must maintain a stable and relatively rapid economic development through further expanding domestic demand, adjusting the relationship between investment and consumption, keeping the investment scale in control and reinforcing consumption's pulling effect on economic growth". According to information from National Reform and Development Commission, Ministry of Finance, etc, the main policy measures to boost domestic demand include reducing tax, increasing household income, speeding up infrastructure building in rural areas and providing supports with various financial policies.
Tax reduction includes lowering the personal income tax through threshold increase from the original 800 yuan to 1600 yuan. The Ministry of Finance estimates that about 30 billion yuan will be released after this policy adjustment. If these entire amount were used for consumer expenditure, annual household consumption would grow by 0.4 percent annually on an average basis.
The other tax reduction policy is abolishing agricultural tax thoroughly. At end 2005, a total of 183 billion yuan was arranged from the central government budget as transfer payment to support rural tax and fee reform and agricultural tax abolishment. From 2006 onward, fiscal authorities will arrange 103 billion yuan annually to support the consolidation of tax and fee reform in the countryside, with 78 billion as transfer payment from the central government to local government, and 25 billion from local government budget.
In terms of increasing household income, related government agencies have already come up with ideas on establishing a minimum wage system in order to raise wage level and increasing the income of medium and lower income households in urban China. Given the relatively low propensity to consume of urban residents, the 11th "Five-year Program" focuses on boosting rural residents' income and consumption through building a socialist new countryside and adopting all kinds of measures ( for example the tax and fee reduction mentioned above).
The relevant agencies indicate that rural infrastructure building shall be accelerated in the following aspects: first, at end 2004, a total of 10.3 billion yuan raised by issuing Treasury Bonds were invested in drinking water safety projects; second, rural energy building shall be expedited, including actively introducing clean energy technologies such as small hydro power plants, solar and wind powers, and etc; third, supporting projects of rural electric network upgrading shall be completed as soon as possible; forth, the state shall invest 100 billion yuan to strengthen road construction in rural areas so that all the townships are accessible by blacktop or cement roads, all qualified administrative villages in east and central China are accessible by blacktop or cement roads while all qualified administrative villages in west China are basically accessible by roads by the end of 11th "Five-year Program".
In the financial field, a very important measure is to encourage financial institutions to extend consumer credits targeted at individuals, encourage residents to change their traditional consumption habits and consumption culture and advocating appropriate consumption on future income. In recent years, household consumer credit has grown by 50 per cent annually from 170 billion yuan to 2200 billion yuan; housing mortgage loans have increased by about 58 per cent annually; household automobile loans have increased by about 40 percent annually. Some foreign automobile companies such as GM and Ford have even established their auto financial service companies in China to provide auto loans.
How do you see the high savings rate in China now?
Savings consist of national, corporate and household savings. There are many factors such as traditional culture, social structure, and emphasis on family behind China's high household savings rate at the current stage. One of major reasons lies in the incomplete social security system. The ordinary people have accumulated a large amount of precautionary savings for the purpose of pension and medical care. In the meanwhile, housing system reform has resulted in significant savings for housing needs, and saving for children education is another reason contributing to high savings rate.
High savings rate and huge foreign reserves are not only seen in China, but also in other Asian countries. In this respect, the Asian financial crisis has had negative impact on the behavior pattern of government and household in Asian countries. Take Malaysia as an example, the BIS statistics showed that its national savings rate was below 35 percent before the crisis, and hit 42 percent during the crisis. On the contrary, the US household savings rate stood at around 4-5 percent before the crisis, but began to decline substantially since 1999, and down to negative territory now (the lowest level was -1.6 percent in the third quarter of 2005). So these dynamics are related to the Asian financial crisis. Asian countries complained a lot about the crisis. On the one hand, complaints go to the attack of hedge funds, on the other hand, complaints go to the IMF for their failure in responding promptly and offering sound policy suggestions to ease the distress caused by the crisis. Therefore, Asian countries tend to rely more on themselves, through household and government savings, to prepare for the next potential crisis.
There are also debates regarding the issue of savings rate. China and the US are on the two extremes with respect to savings. We need to pay attention and study the impact of savings on trade balance.
What are the measures that have been adopted to reduce the Savings Rate?
One of the measures that need to be taken is to accelerate reform of the social security system and the education system to reduce precautionary savings. And relevant departments have taken a series of measures to reform the pension, medical care, education and housing mortgage loan systems, so as to provide incentives for the consumers to convert long-term demands into current demands.
We have learned from the Ministry of Labor and Social Security that China's pension system was established in 1997 and the contributions ratio now has reached about 40 percent, second only to Singapore in Asia. As an effort to promote pension system reform, income tax, business tax and stamp duties have been exempted for operations of the social security fund. Besides, starting in 2006, pension contribution by the employees will be reduced to encourage more participation in the pension system. Measures to be taken in the coming periods include expanding the coverage of the pension system from the State-owned enterprises to the private and non-state enterprises and initiating studies over an old-age insurance system for the rural migrant workers.
With regard to the reform of the medical insurance system, basic medical insurance system has been established for the urban workers, with the coverage being gradually expanded to include the medium and small enterprises as well as various types of employees and retirees. According to the 11th "Five-Year-Program", starting from this year, community health services in the urban areas will be vigorously developed, while in the countryside, constructions and planning of health projects will be forcefully promoted, and the pilot cooperative medical system in the rural areas will be expanded to 40 percent of the counties (prefectures).
Concerning the reform of the education system, according to information from the Ministry of Education and Ministry of Finance, China will strengthen financial support to education, with budgetary education expenditures to be gradually increased to 4 percent of the GDP. At the same time, private schools and education will be fostered and social contributions to education will be encouraged. In terms of financial policy support, student loans will be developed. The annual growth rate of student loans has averaged at about 170 percent since 2001.
According to the 11th "Five-Year-Program", the funding mechanism of rural compulsory education will be reformed to include the rural compulsory education into public expenditure. Within the two years of 2006 and 2007, tuition will be waived for rural students throughout their years of compulsory education. At the same time, funding for rural compulsory education will be gradually increased. Between 2006 and 2010, the fiscal authorities at the central and local level will raise the rural compulsory education expenditure by a total of 218.2 billion yuan.
In terms of developing the housing mortgage loan market, over the recent years, the People's Bank of China has been facilitating the growth of housing mortgage loan business. Since 2000, housing mortgage loans have been growing at an annualized rate of 58 percent. Thanks to the reform measures in the housing market (including measures taken to reform the primary and secondary markets), 80 percent of the urban households have their own homes. In the countryside, almost all residents have their own homes. In the years to come, more focused financial policies will be adopted to develop housing mortgage loan business.
Would you please introduce the progress China has achieved in market opening-up?
Since the start of reform and opening-up, China has made tremendous efforts in opening the domestic market to foreign competition. Currently, the opening-up degree of the Chinese economy is fairly high, which is reflected in the greatly reduced tariffs (for example, the tariff on saloon car has dropped to 28 percent), many eliminated non-tariff measures including import license, import quota and import tendering and liberalized 245 products that had been subject to designated trading. For telecommunication services, foreign services suppliers were permitted to establish joint-venture value-added telecommunication enterprises, without quantitative and geographic restrictions. For wholesale services (excluding salt and tobacco), hotels and restaurants, restrictions in market entry were abolished, broadly realizing opening-up to the outside world.
Great progress has been achieved in liberalizing the financial industry as well. In banking sector, foreign exchange business has opened up in full scale to foreign-funded banks; at the same time, RMB business has expanded to 25 cities. Insurance sector achieved the highest opening-up degree and basically realized opening-up to the outside except that the share of foreign companies in a joint venture life insurance company shall be no higher than 50 percent and the share of foreign companies in a joint venture insurance brokerage company shall be no higher than 51 percent. In the opening-up of capital market, Qualified Foreign Institutional Investors (QFII) have been encouraged to enter the domestic capital market to promote market development. The foreign shares in the joint-venture fund management companies were raised gradually. Development of the bond market has been underway with international institutions introduced to issue RMB bonds in the domestic market.
In accordance with its WTO commitments, by end-2006, China will grant national treatment to foreign banks by removing all restrictions on their RMB businesses. Foreign insurance companies will be allowed to establish wholly-funded subsidiaries in China. The Chinese authorities will, taking into account the stage of development and the abilities to absorb shocks of the financial sector, further enhance financial openness in a gradual, active and open-minded manner, while at the same time strengthening the regulation over the financial system.
What policy measures will be taken to expand imports?
In the Government Work Report delivered at the 4th Session of the 10th National People's Congress on March 5, 2006, Premier Wen Jiabao pointed out that, during the 11th Five-Year Plan period, China will make efforts to change the pattern of trade growth, improve trade structure, and correct the imbalance between exports and imports..
The Chinese government will take measures to encourage imports by adjusting relevant policies and improving the policy environment. The import strategy China currently adopts is in line with China's situation as well as the overall plan for economic and social development and the industrial policies. China will particularly increase the import of advanced technologies, key equipments, and the resources that are in short supply in China. We have learned the following from the relevant authorities
The import tax policy will be further improved to encourage companies to import resources and commodities that fit in with China's industrial policies and benefit national economic development. Greater support will be given to companies to facilitate their import operations. Efforts will also be made to strengthen the development of infrastructure by increasing the import of equipments, particularly from the developed countries.
With its IT industry developing very rapidly, China now stands at a critical stage. It needs to import large amount of IT products and equipments, such as products containing Intel chips and network equipments, from the developed countries. The Chinese banks will also need to purchase lots of mainframe computers to conduct system transformation.
China's aviation market is in the initial stage of development and has great growth potentials. It is expected that China's aviation market will prosper for several decades, and its imports of airplanes and related equipments and parts will grow rapidly in the coming years and even decades. According to the Boeing's long-term forecast of aircraft market released on March 7, 2006, China will be the largest aircraft market in Asia and the Pacific between 2005 and 2024 and is estimated to purchase a total of 2600 new planes in the said 20 years. In 2005, a deal was reached in which China ordered 70 aircrafts from Boeing worth of US$4 billion.
China is also one of the largest importers of agricultural products in the world market. China's annual soybean import is about 20 million tons. China's import demand for cotton has been increasing. As the biggest buyer of US cotton, China imported a total of 1.206 million tons from the U.S. in 2005, up 14 percent over the previous year. China's imports from the world market of agricultural products are expected to increase further.
The combination of the above measures will enable china to rely more on domestic demand and less on exports, thus promoting more balanced development of the Chinese and world economy. It is expected that, with several years' efforts, China will realize a broad equilibrium in foreign trade.
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