Thursday, April 20, 2006

Rapid Economic Growth at Home Adds to Heat on Hu to Adjust Yuan

By ANDREW BROWNE
April 20, 2006; Page A1

BEIJING -- Adding to U.S. pressure on President Hu Jintao to let the yuan appreciate, China's growth at home is surging so quickly it risks overheating.

Driven by exports and rapid development, China's economic growth raced ahead by 10.2% in the first three months of this year, even faster than the blistering 9.9% pace registered for all of 2005.

The speed appears to have taken Mr. Hu by surprise. "We do not want, nor are we pursuing, over-rapid economic growth," he said Sunday. But it is getting harder for Beijing to hold the line as its trade surplus hits record highs and sucks in vast amounts of cash.

China's trade surplus swelled to $12 billion for the first two months of the year, up from $10.8 billion a year earlier. Isaac Meng, an economist at BNP Paribas in Beijing, said he expects China's surplus to hit $130 billion this year, $28 billion more than last year's record.

[CECON]

China spurns arguments by U.S. politicians that its massive trade surplus with the U.S. -- $202 billion last year, by Washington's calculations -- is the result of a steeply undervalued yuan. Since it raised the value of the yuan by 2.1% against the U.S. dollar last July, China has allowed the currency to gain only 1% or so more.

Yesterday in Seattle, Mr. Hu reiterated a pledge to gradually liberalize China's currency policy, but reaffirmed his commitment to keep its exchange rate "basically stable at an adaptive and equilibrium level" -- underlining a reluctance to move too precipitously on currency policy. (See related article1.)

Still, the exchange-rate issue is likely to be high on the agenda during Mr. Hu's meeting with President Bush today. While few expect Beijing to engineer another one-off currency revaluation, there are increasing expectations that Chinese policy makers -- seeking to cool the economy at home -- could allow a faster pace of appreciation for the rest of this year.

Many Western economists agree with Beijing that further appreciation of the yuan wouldn't itself do much to improve the U.S. trade deficit. But some also say a powerful argument may be building to allow for a stronger yuan given the growth of China's economy. A stronger yuan could help slow the influx of currency into the country, both by making Chinese assets more expensive for foreign investors and by making Chinese exports less desirable to foreign buyers.

Signs of possible overheating are everywhere here. Investment in factories, highways and other fixed assets jumped 27.7% in the first three months of this year over the same period a year earlier, according to state media. The broadest measure of money supply grew 18.8% in March from a year earlier, higher than the official 16% target.

Easy bank credit is flowing again after more than a year of austerity. Commercial banks already have dished out more than half their targeted loan total for the full year. Funds are so plentiful that banks are cutting loan rates as they scramble for new business.

"Banks are chasing us to lend money," said Chen Tongkao, chairman of Zhejiang Dongfang Shipbuilding Co. Mr. Chen said that last month the company secured a 200 million yuan ($25 million) loan from state-owned Agricultural Bank of China at 5% interest, a discount over the official "guidance rate" of 5.58% for a one-year loan. The money will go toward building an 800 million yuan production line to make oil and chemical tanks for export.

Increasingly, the concern is that China is drawing in so much cash that it will spur inflation. Economists say the flood could feed an investment bubble, raising the risk of bad bank loans and wasteful investment. If such a bubble popped, it could mean massive overcapacity that leads to collapsing prices and industrial bankruptcies -- which has happened to China in the past, most notably in the mid-90s.

A downturn likely would ricochet throughout U.S. and other Western businesses because they are invested in China to an unprecedented degree. Also vulnerable: a slew of venture capital and private equity investors who could see their record-setting investments collapse if there were a sudden turn in the economy, similar to the popping of the U.S. Internet bubble early this decade.

The best gauge of the problem facing Mr. Hu may be the buildup of China's foreign-exchange reserves, the currency reserves held by the central bank. These grew by $21.4 billion in March to reach $875.1 billion, making them the largest in the world. Before long, the reserves are likely to exceed $1 trillion -- almost half the size of the Chinese economy.

The reserves are so bloated because of Chinese central bank intervention to prevent the yuan from strengthening too quickly. The bank buys dollars as they flood in from exports, investments and speculative "hot money," and sells yuan. The resulting glut of yuan suppresses its value but also floods the economy with liquidity. Authorities try to mop up the excess cash by issuing yuan-denominated bonds that are bought by banks.

Still, with cash-rich banks rushing to lend as the reserves swell, there's a danger of a new investment bubble, inflation and an increase in the amount of bad loans. Last week, Premier Wen Jiabao held a cabinet meeting and called for "comprehensive measures to solve the problem of fast growth in bank lending," according to a report posted on the Chinese central bank's Web site.

[Hu Jintao]

Elsewhere in the world, central banks might consider raising interest rates to deter borrowing. But in China, higher rates could add to the problem by sucking in more "hot money" betting that Beijing will have to relent and allow the yuan to rise faster. Such flows have picked up again this year after tailing off last year, economists say.

Economists say they believe Chinese leaders are anxious to avoid hitting the brakes on growth this time. China is still exporting excess production built up during the previous investment boom, and killing domestic demand would likely unleash yet another wave of exports, adding to the country's already bloated trade surpluses.

Instead, Beijing also has been hoping to ease the economy's dependence on exports and investment by refocusing growth toward domestic consumption. A few weeks ago, Premier Wen unveiled a domestic stimulus program, including measures to abolish an agricultural tax, boost infrastructure spending and increase government investment in the country's health and education systems.

The central bank also is trying to reverse the huge currency inflows. Last week, it announced measures to allow Chinese individuals and ordinary companies to invest in overseas shares and bonds for the first time. Also, the bank said individuals will be able to exchange Chinese yuan for as much as $20,000 each year, up from $8,000. Companies involved in trade will be given more freedom to buy foreign currency.

Up to now, China has imposed severe restrictions on the use of foreign exchange. It is miserly with the amounts it allows students to take overseas, and even getting dollars to pay for a visa can be a hassle. Smaller companies trying to get foreign currency to purchase imports often run into a tangle of bureaucracy.

In relaxing its foreign-exchange policies, economists say, the government wants to hold less foreign exchange, and have companies and individuals hold more. But over the longer run, they say, demand for dollars to invest overseas could depress the value of the yuan relative to the U.S. currency.

Even in the short term, the relaxation moves are not likely to substantially shrink China's reserves, which are growing at a pace of some $200 billion each year, says Calla Wiemer, a China expert at the National University of Singapore. "That means pressure to appreciate [the yuan] will continue," she said.

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