VZCZCXRO8958
OO RUEHCN RUEHGH
DE RUEHHK #1921/01 1300020
ZNY CCCCC ZZH
O 100020Z MAY 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6571
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASH DC

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 001921 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
STATE PASS USTR 
USDOC FOR DAS LEVINE, ITA/OCEA MCQUEEN AND CELICO 
TREASURY FOR KOEPKE 
NSC FOR WILDER 
 
E.O. 12958: DECL: 05/09/2031 
TAGS: ECON EFIN PREL CH HK
SUBJECT: CHINA'S ECONOMIC POLICIES THE FOCUS OF FINANCIAL 
ATTACHE LOEVINGER'S HONG KONG MEETINGS 
 
Classified By: E/P Chief Simon Schuchat. Reason: 1.4 (b,d) 
 
 
SUMMARY 
------- 
 
¶1. (C) Hong Kong-based investment bank analysts and 
economists generally welcome China's recent economic 
tightening measures, and some believe that recent and 
significant appreciation of Asian currencies may lead to 
quicker upward movements in the value of the renminbi (RMB). 
They used the occasion of meetings held May 2-5 with Embassy 
Beijing's newly-arrived Financial Attache David Loevinger to 
suggest that U.S. efforts to get China to move on currency 
appreciation and capital account liberalization are most 
effective when presented via private diplomacy and in the 
context of the mainland's own long-term economic interests. 
Loevinger also discussed the apparent near-intractability of 
China's high rate of precautionary savings and heard several 
analyses of how uncertainty about future needs for education, 
health care, housing, and retirement drives consumers to 
minimize their day-to-day spending.  END SUMMARY 
 
VISIT DETAILS AND MEETINGS 
-------------------------- 
 
¶2. (U) Embassy Beijing's newly-arrived U.S. Treasury 
Financial Attache David Loevinger held meetings in Hong Kong 
May 2-5 with investment bank analysts, academics, economists, 
and Hong Kong Government officials, including: 
 
-- William Ryback, Deputy Chief Executive, Hong Kong 
   Monetary Authority 
-- Guonan Ma, Senior Economist 
   Bank of International Settlements 
-- Jonathan Anderson, Managing Director, UBS 
-- Hong Liang, Executive Director, Asia-Pacific Research, 
   Goldman Sachs 
-- Jun Ma, Managing Director, Deutsche Bank 
-- Grace Ng, Managing Director, JP Morgan 
-- Simon Ogus, Chairman, Dismal Science Group (DSG) 
-- Hongbin Qu, Senior China Economist HSBC 
-- Jim Walker, China Economist, CLSA 
-- Geng Xiao, Associate Professor of Finance, Hong Kong 
   University 
-- Andy Xie, Managing Director, Morgan Stanley 
 
 
BROADER MEANING IN RECENT INTEREST RATE HIKE 
-------------------------------------------- 
 
¶3. (SBU) China raised lending interest rates by 0.27 percent 
to 5.85 percent on April 27.  Our interlocutors downplayed 
the economic significance of the hike itself but saw broad 
significance in the move.  UBS's Anderson believes the 
increase signals to banks that the People's Bank of China 
(PBC) is getting serious about reining in recent credit 
growth, a danger in particular for the property and 
construction sectors, and may take administrative action to 
follow it up.  That said, the small magnitude implies that 
the PBC is not concerned overall with economic overheating. 
 
¶4. (C) CLSA's Walker disagrees with that interpretation.  He 
observed that the increase has come notably early in the 
current cycle of discussion about overheating and suspects 
that monetary authorities are acting quickly because they 
expect rising commodity prices and wage rates to be reflected 
shortly in inflation trends.  Walker, referring to recent 
conversations with mainland think tank economists, suggested 
that PRC economic policy officials are likely heeding a 
lesson of history: once inflation is embedded in China's 
economy, it is hard to stop without a shock to the system. 
In line with Walker's views, HKMA's Ryback praised the PBC 
for its early intervention, commenting that it is better to 
brake now than later.  He noted that Hong Kong's benchmark 
stock index for China listings had rebounded quickly after 
the shock of the news; this suggests a broad acceptance that 
mainland officials are acting appropriately to preserve 
better prospects for the long run. 
 
TRICKY CURRENCY POLICY ENVIRONMENT 
---------------------------------- 
 
 
HONG KONG 00001921  002 OF 003 
 
 
¶5. (C) The China watchers listed changing conditions that 
support a more rapid rise in the RMB, but they made clear 
that appreciation has been held in check in part because of 
conservative voices in the Chinese government (e.g., NDRC, 
Commerce) and sensitivities about economic relations with the 
U.S.  They observed that the undervalued RMB is drawing in 
excess foreign currency, complicating needed efforts to 
restrain credit growth.  Goldman's Liang said that 
appreciation of other Asian currencies this year increases 
the likelihood of the RMB rising more quickly.  (Note: As of 
May 8, the Korean Won was up nearly 9 percent, the Singapore 
dollar 6 percent, the Japanese yen 5 percent.  End Note.) 
This trend not only reduces the trade-weighted value of the 
RMB but also creates the unwelcome prospect of trade tensions 
between China and Asian trade partners -- and besides, China 
is by nature a "follower" in taking action on regional 
financial challenges.  JP Morgan's Ng suggested that the RMB 
might have moved more on the occasion of Hu's visit to 
Washington had the Chinese side not concluded that U.S. 
late-game emphasis on IPR issues implied that a currency 
deliverable was not necessary.  Like Liang, she focused on 
the trade-weighted value decline of the RMB and concluded 
that the down-trend of the USD among other currencies offers 
China a very good opportunity for letting significant 
appreciation go forward. 
 
¶6. (C) Liang and Ng separately emphasized the importance that 
Japan's experience with currency appreciation plays in the 
minds of NDRC economists and others in the economic 
bureaucracies.  While there is a debate to be had about just 
what caused Japan's lengthy stagnation in the 1990s, Chinese 
policy makers are clearly wary of how the 1985 Plaza Accord, 
which led to yen appreciation, is often cited in the chain of 
events that made it difficult for Japan to deal with a 
recession some years later.  Ng said that China sees itself 
as a much poorer country than Japan was in 1985 and therefore 
less capable of dealing with any resulting shocks from a RMB 
rise. 
 
¶7. (C) HKU's Geng emphasized the role that anxieties about 
inflation and deflation play for China in crafting RMB policy 
approaches.  He lamented that China does not have a higher 
rate of inflation -- perhaps 5 percent would be desirable -- 
as this would be typical of an economy experiencing such high 
levels of growth and transition.  Since productivity is 
rising rapidly, it is only natural that the prices of 
non-tradable goods would rise relative to tradables, i.e., 
changes in relative prices should be expected.  The public, 
however, has strong negative associations with inflation 
based on experiences in the 1970's and 1990's.  Meanwhile, 
overcapacity in sectors like steel and cement leaves policy 
makers fearful of igniting deflation through a currency hike. 
 Were the public accepting of moderate inflation and were 
this to already exist in the economy, then the pondered 
effect of a rising RMB would merely be a decrease in the 
inflation rate rather than the prospect of slipping into 
deflation. 
 
SUGGESTIONS FOR U.S. DIPLOMACY 
------------------------------ 
 
¶8. (C) We received numerous comments that the U.S. messages 
to China on currency policy and financial liberalization 
should be delivered privately and should be packaged with 
emphasis on why taking various steps is in the interest of 
the mainland itself.  "Bullying" that is done in the context 
of U.S. domestic political debates is counter-productive, in 
the view of several of the China watchers we met with. 
Morgan Stanley's Andy Xie said the U.S. will continue to be 
challenged by a historical Chinese attitude that dangers 
ahead are best approached by "muddling through."  In his 
view, the U.S. should propose packages of measures that taken 
together would not amount to "shock therapy" for a society 
that is already very tense amidst economic transition. 
Goldman's Liang said the U.S. needs to bolster its own 
credibility by showing that it will reduce its fiscal 
deficit.  In her view, China's leadership sees the unwinding 
of global imbalances as a question of burden sharing. 
China's approach with the U.S. is actually an act of 
bargaining over who will feel what economic pain.  JP 
Morgan's Ng emphasized the "face" aspects of public 
criticism, cautioning that the most likely factor in whether 
RMB appreciation is slowed from what it would be otherwise is 
 
HONG KONG 00001921  003 OF 003 
 
 
America's public posture on the issue.  BIS's Ma said the 
U.S. should note to China how currency liberalization would 
lift China's capacity to manage economic shocks and crises. 
 
PRECAUTIONARY SAVINGS 
--------------------- 
 
¶9. (SBU) There was little optimism on the issue of 
precautionary savings, i.e., the tendency of Chinese 
consumers to save a high proportion of income in response to 
concerns about future requirements with regard to education, 
health care, housing, and retirement.  Morgan Stanley's Xie 
called on the PRC to boost consumer spending power with bond 
issuances aimed at rural residents and through distribution 
of proceeds from the sale of state assets.  A major challenge 
is the erratic nature of future costs, e.g., costs for 
medical treatment are unclear or inflated by corruption while 
education fees are erratic in their composition and rising 
quickly.  HSBC's Qu noted that much of what is saved is for 
specific goals (e.g., housing), so efforts to raise returns 
on savings should help -- such as recently announced 
provisions to allow for limited individual investment in 
assets abroad.  BIS's Ma suggested that the savings issue is 
aggravated by the one-child policy -- working parents are 
concerned at the prospect of having only one child to assist 
them in retirement -- a factor that is not going to go away 
any time soon. 
Cunningham