Q+A-Yuan is part of broader Chinese economic rebalancing

By Alan Wheatley, China Economics Editor

HONG KONG, April 29 (BestGrowthStock) – A rise in the yuan would
make Chinese exports less competitive and cut the cost of
imports, providing incentives for capital and labour to be
redeployed towards the domestic sectors of the economy.

But the exchange rate is just one of myriad variables that
determine a country’s current account balance, which, by
definition, reflects the difference between domestic savings
and investment.

In China’s case, savings dwarf its already massive
investment, resulting in a large current account surplus that
is the object of fierce criticism by U.S. lawmakers who say it
goes to the heart of imbalances in the global economy.

Yet Anoop Singh, director of the International Monetary
Fund’s Asia and Pacific Department, cautioned against expecting
an overnight solution. Reducing China’s savings called for a
battery of policies over the medium term, he told a news
conference in Shanghai on Thursday. [ID:nTOE63S022]

“This will require a mix and a range of policies. It is
very important that this package of measures is not viewed as
based on one policy, which is the exchange rate,” Singh said.

Here are some questions that Chinese rebalancing raises.

WHY DOES CHINA SAVE SO MUCH?

China’s gross aggregate savings rate now tops 50 percent of
gross domestic product, by far the highest of any big economy.

From 1997-2007, the savings rate of enterprises rose by
11.1 percentage points and the government’s savings rate rose
by 4 percentage points; but the household savings rate fell 1.8
percentage points, Citigroup economists Willem Buiter and
Minggao Shen noted in a report.

For a related analysis [ID:nSGE61F01U]

Still, household savings are high. Because China has a
flimsy social safety net and underfunded public services,
people salt money away for their old age and to pay for medical
bills and school fees.

WHY HAVE FIRMS BENEFITED AT THE EXPENSE OF THE WORKERS?

The most significant “imbalance” in China is a low and
declining share of household disposable income. Growth in
incomes has been fast but has not kept pace with the overall
expansion of the economy.

The wage share in total income fell to 39.7 percent in 2007
from 52.8 percent a decade earlier, according to Louis Kuijs, a
World Bank economist in Beijing.

Two major factors have driven this development.

First, rapid growth of the labour force has kept a lid on
wages as tens of millions of farmers have left the land for
urban jobs.

Second, contrary to conventional wisdom, Chinese
manufacturing is very capital-intensive. So the marginal demand
for labour has been relatively low except in a few
export-oriented sectors such as textiles and shoes.

The first part of this equation is changing. Labour
shortages are widespread in coastal regions because migrant
workers are finding more jobs nearer home as growth spreads
inland.

And now that their families have escaped poverty, young
migrants are no longer as willing to make the same sacrifices
as their parents, working for a pittance in poor conditions far
from home.

The result is that labour costs are rising fast. The
minimum wage in Guangdong, which accounts for nearly a third of
China’s exports, will rise over 20 percent next week.
[ID:nTOE62H010]

However, the reasons why China has a capital-heavy economic
model remain. Chief among these is the low cost of borrowing.

For favoured firms that have access to bank credit, the
benchmark rate for one-year loans is 5.31 percent, half the
current real GDP growth rate.

To attract tax-generating industries, local authorities
also offer tax breaks and cheap land. Water and power tariffs
are low by international standards and the cost of complying
with environmental and health and safety standards is not
onerous.

HOW DOES THE FINANCIAL SYSTEM AMPLIFY THE IMBALANCES?

Chinese firms, especially state-owned enterprises, have a
strong bias to retain earnings to finance fixed and inventory
investment plus working-capital needs, Buiter and Shen said.

This is partly because of constant worries that regulators
might impose credit quotas without warning. Underdeveloped
commercial paper and bond markets are also a factor.

So, although state financing and bank loans for capital
spending surged by more than 50 percent in 2009, other sources,
including retained earnings, still provided three-quarters of
all financing for investment, the IMF said in Thursday’s
report.

State-owned companies are abetted in their eagerness to
save — and to channel their profits back into ever-more
investment — because the central government requires them to
hand over no more than 10 percent of their profits as
dividends.

As a result, the state is deprived of revenues that it
could spend on more generous transfer payments to households.
These would have a powerful effect on consumption: the IMF
calculates that every yuan spent by the government on health
frees urban families to spend two extra yuan on consumption.

Private companies retain their profits to finance expansion
because only a few have access to bank loans.

Banks are nearly all state-owned and have scant incentive
to take the risk of allocating part of their credit quota to
borrowers not implicitly or explicitly backed by the
government.

WILL THINGS CHANGE?

They already have in some respects.

China’s working-age population will peak around 2016,
reinforcing the unfolding trend towards higher real wages and
raising the labour share of income. That in turn should boost
household consumption, which fell to just 35.8 percent of GDP
in 2008, a record low for a major economy in peacetime.

Rising per capita incomes should also reduce the need to
save so much for a rainy day, especially if the government
keeps strengthening the social safety net.

Spending on healthcare rose 163 percent between 2005 and
2008. Outlays on education and social security rose 125 percent
and 83 percent, respectively, over the same period, noted Andy
Rothman, a macro strategist for CLSA in Shanghai.

Measures in train to make it easier for farmers to settle
in cities with their families will also accelerate the
development of an urban-based service economy, boosting
consumption.

Other aspects of the economy will be slow to change. China
still has huge infrastructure needs, so investment will
continue to account for a large share of GDP growth.

Learning the lessons of the financial crisis, China is
likely to be slow to liberalise its banking system. That will
restrict the availability of personal credit and force people
to save for big purchases. And pension systems cannot be built
overnight.

In short, the process will be gradual.

Investing Basics
(Reporting by Alan Wheatley; Editing by Ken Wills and Tomasz
Janowski)

Q+A-Yuan is part of broader Chinese economic rebalancing