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DE RUEHHK #1839/01 1231101
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P 031101Z MAY 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 6474
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 02 HONG KONG 001839 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
TREASURY FOR OASIA GKOEPKE 
STATE PASS USTR 
USDOC FOR 4420 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV HK CH
SUBJECT: CHINA CURRENCY AND MACRO POLICY: IMF'S 
PRESCRIPTIVE APPROACH OVERLOOKED BY MEDIA 
 
(U) THIS DOCUMENT IS SENSITIVE BUT UNCLASSIFIED.  PLEASE 
PROTECT ACCORDINGLY.  NOT FOR RELEASE OUTSIDE U.S. GOVERNMENT 
CHANNELS.  NOT FOR INTERNET PUBLICATION. 
 
INTRODUCTION/SUMMARY 
-------------------- 
 
¶1. (SBU) Media coverage of the International Monetary Fund's 
(IMF) May 2 unveiling in Hong Kong of its Asia-Pacific 
regional outlook is based primarily on an advance press 
release and does not capture the prescriptive approach put 
forward at the event with regard to China's currency and 
macroeconomic policies.  The IMF used the event to call on 
China to (a) exercise greater currency flexibility and (b) to 
increase spending on education, health care, and retirement 
as a way to reduce the need for "precautionary savings."  END 
INTRODUCTION/SUMMARY 
 
PRESENTATION IN HONG KONG 
------------------------- 
 
¶2. (SBU) On May 2 in Hong Kong, the IMF Deputy Director for 
Asia, Wanda Tseng, presented the latest Regional Economic 
Outlook (REO) for the Asia-Pacific region.  A full copy of 
the REO is available on www.imf.org.  The purpose of this 
message is not to summarize the full report but to highlight 
a number of China- and Hong Kong-related comments made at the 
event that are likely to be of interest to analysts and 
policy makers. 
 
CALL FOR RMB FLEXIBILITY 
------------------------ 
 
¶3. (U) Tseng observed that despite the introduction of a new 
currency regime in July 2005, the renminbi (RMB) has only 
risen 1.25 percent since the initial 2.1 percent revaluation. 
 Though unwilling to provide a target for the RMB's vale 
when asked, Tseng noted several times that Chia is not using 
the full flexibility available toit under the new RMB 
value-setting system.  Ther is a hig cost and a loss of 
policy flexibility ssociated with China's policy of 
partially steriizing excess foreign exchange inflows.  One 
negaive result of this approach is the introducion of 
excess liquidity into the mainland economy, which in turn is 
fueling a resurgence of loans and investment that needs to be 
reined in. 
 
EMPHASIS ON CHINA AND U.S. IN EFFECTING ORDERLY ADJUSTMENTS 
--------------------------------------------- -------------- 
 
¶4. (U) Tseng made repeated reference to the U.S. current 
account deficit along with China's accumulation of foreign 
exchange reserves.  She suggested a role for both the U.S. 
and China in managing global financial imbalances.  At this 
point, there is no apparent problem in managing the 
situation, but there is likely medium-term risk considering 
that there is a limit to how much of the U.S. current account 
deficit foreigners are willing finance.  When asked whether 
the U.S. or Asia had a more important role to play in working 
out imbalances, Tseng responded by referring exclusively to 
the U.S., which she said must act "urgently"; a rise in U.S. 
savings will be key.  With regard to China's foreign exchange 
reserves, Tseng would not name a figure that could be deemed 
"adequate," but stated that China has "no need to go further" 
in its accumulation. 
 
REBALANCING CHINA'S ECONOMY 
--------------------------- 
 
¶5. (U) The REO report suggests "a very stark picture" 
emerging from the fact that household consumption in China 
only accounted for approximately 40 percent of GDP last year. 
 Although such consumption has grown at an average annual 
rate of 8 percent since the early 1990's, this lags GDP 
expansion.  Savings now make up approximately 30 percent of 
GDP.  One factor in the high savings rate is "precautionary 
savings motives," resulting in part from the decreasing role 
of state-owned enterprises in the provision of pensions, 
health care, and schooling -- and much of this responsibility 
has now been transferred to central and local governments 
that face budget crunches. 
 
¶6. (U) Consequently, education spending is now only about 
2.25 percent of GDP, the lowest among Asian economies, while 
 
HONG KONG 00001839  002 OF 002 
 
 
the proportion given to health care is 0.5 percent of GDP. 
Making up for low expenditures in these two areas consumes an 
increasing proportion of household consumption.  Uncertainty 
about such expenses in the future as well as anxieties about 
funding old-age support -- which, in part, derives from the 
effects of the one-child policy -- underpins the need for 
precautionary savings.  Tseng suggested that China reduce the 
uncertainty facing households (and therefore promote their 
propensity to consume) by boosting government spending on 
education, health care and pensions.  The need to save can 
also be reduced through banking reform, which improves access 
to credit, reducing the need to accumulate funds to finance 
major purchases or small family businesses.  Household 
consumption might also be boosted through exchange rate 
flexibility if RMB appreciation raises purchasing power. 
 
HONG KONG STANDS TO GAIN 
------------------------ 
 
¶7. (U) Tseng, joined by IMF Resident Representative Paul 
Gruenwald, said that the demand from the mainland for Hong 
Kong business services remains high.  This is a huge 
advantage for the city in the context of public anxiety 
expressed here about the potential for "marginalization." 
Recent steps to allow mainlanders to invest individually in 
offshore financial instruments are welcome, but the impact on 
Hong Kong is likely to be small in the near term.  The peg of 
the Hong Kong dollar to the U.S. dollar has worked well, but 
its continuation is a local choice.  The IMF forecasts that 
Hong Kong's GDP will likely expand 5-5.5 percent this year, 
down from 7.3 percent in 2006. 
Cunningham