The Chinese government has finally acted to cool the overheated economy. Taking the reins in the first major restructuring of the financial system since 1949 is vice premier Zhu Rongji, the country's rising star. His recent appointment as governor of China's central bank, the People's Bank of China (PBOC), in place of Li Guixian, is a clear indication that the Chinese government is serious about restoring confidence in the economy and the RMB.
To do this, Zhu boosted the power of the central bank and announced a 16-point plan designed in the short term to address particularly acute problems, and in the longer term to assert greater macroeconomic control. The measures announced by the government include:
* Immediate action to reduce government expenditure by 20 per cent.
* Creation of an efficient tax collection system and the abolition of unauthorised levies imposed by local authorities.
* Orders to withdraw unofficial loans, estimated to be between US$100bn and US$200bn, used for property and securities speculation and instead direct the capital towards authorised infrastructural projects. This is seen as a move to boost infrastructural development and to slow down vital real estate development which had been growing too quickly. The aim is to create a more manageable economy and help reduce inflation by directing capital to longer term and lower risk projects.
* Elimination of independent interest rate hikes and "commissions" on deposits by banks, and an end to free-flowing loans to enterprises run by banks.
* Clamp-down on foreign car sales to state-owned enterprises. Cars represent China's sixth largest import commodity. The restriction is seen as another step in helping the RMB by reducing the demand for foreign currency needed to purchase these cars. (China's trade deficit, according to an official report, doubled in two months to US$3.54bn by the end of June.)
Soon after the announcement of the 16-point plan, the PBOC admitted that it had intervened in the country's largest swap market in Shanghai, selling more than US$30m on July 20th, the RMB rose to 8.6 to the US dollar from 9.05 a day earlier.
This active support may be an indication that the government intends eventually to unify the swap and official rates of the RMB (fixed at 5.7 to the US dollar), eliminating Foreign Exchange Certificates (FEC) in the process, with the aim of instituting a single currency convertible on international money markets. At present, FECs frequently exchange at a 15 per cent premium over the RMB.
A consistently strong Chinese currency would allay many of the fears associated with China's overheated economy. This can, in part, be attributed to Deng Xiaoping's effort to reignite the economy by encouraging high-speed growth, during his tour of the southern coastal provinces in 1992. This move unleashed pressures which had built up during the 1989-91 economic retrenchment, and all sectors of commerce and industry spent and lent with abandon. The free-spending placed great strain on the financial system, and have left banks cash-strapped due to indiscriminate lending.
Other measures were announced by the Chinese government to supplement their efforts to strengthen the RMB. The government recently issued US$50m worth of foreign-exchange bonds for the first time with interest rates one point higher than those for US dollar fixed-term deposits (2.75 per cent). A week later, the government raised interest rates on RMB fixed-term deposits, the second raise in as many months, by an average of 1.72 points. One-year and two-year deposits rose to 10.98 per cent and 11.7 per cent respectively; interest rates on six-month loans increased to 9 per cent from 8.82 per cent and one-year loans to 10.98 per cent per cent from 9.36 per cent. The increases in deposit interest rates are designed to lure investors away from speculative investments, formerly their only hope to match inflation.
The Chinese government has shown that it is serious about asserting macro-economic control to combat its serious inflation, reduce the problems of administrative and financial bottlenecks, and ease the strain on already overburdened energy and transportation infrastructure. In the short term, with regular intervention in the RMB swap market and effective measures to improve the liquidity of the banking system, a degree of confidence seems to have been restored. *
Batey Burn is an investment consultancy specialising in China with offices in Hong Kong, Beijing, Shanghai, Tianjin and Shenzhen. The company's principle business is in the identification and structuring of China investments, China market research, and economic and political analysis.
Batey Burn, 701 California Tower, 30-32 D'Aguilar Street, Central, Hong Kong. Tel: +852810 0211, Fax: +852 810 1788.