VZCZCXRO5856
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0808/01 0330617
ZNR UUUUU ZZH
P 020617Z FEB 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 4438
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEHKO/AMEMBASSY TOKYO 1141

UNCLAS SECTION 01 OF 02 BEIJING 000808 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM 
TREASURY FOR OASIA -- DOHNER, HARSAAGER, CUSHMAN 
USDOC FOR 4420 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN EAGR WTRO CH JP
SUBJECT: BANK OF JAPAN REPRESENTATIVE'S CONCERNS ABOUT CHINA'S 
CURRENCY AND MONETARY POLICY CHALLENGES 
 
 
SUMMARY 
------- 
 
¶1. (SBU) The Bank of Japan (BOJ) Chief Representative to China, 
Kiyoyuki Seguchi, said that BOJ is concerned that China's large 
balance of payments surplus and rigid exchange rate are contributing 
to excess liquidity, over-investment, and asset bubbles in real 
estate and stocks, increasing the risk of a boom/bust cycle.  To 
maintain financial and price stability, the People's Bank of China 
(PBOC) might be forced to slam on the brakes, sharply limiting 
lending and making it difficult for borrowers to roll over debt. 
China should avoid such a scenario by tightening monetary policy 
now.  Seguchi said that the PBOC understands the need for renminbi 
(RMB) appreciation but is politically constrained by concerns about 
the adverse impact on: (1) agricultural competitiveness, given the 
rapid rise in imports due to implementation ofChina's WTO 
commitments; and (2) processing sctor (export assmbly) jobs.  He 
said that a 10-20 percent short-term RMB appreciation would cause 
numerous marginal low-end producers to close factories in China, 
noting that the sectors they represent (e.g., textiles) are 
particularly labor intensive.  END SUMMARY 
 
VIEWS ON CURRENCY AND MONETARY POLICY 
------------------------------------- 
 
¶2. (SBU) Seguchi recently told Finatt and Econoff that the BOJ's 
views on renminbi (RMB) valuation are very close to those of the 
United States Treasury.  He said that the BOJ is concerned that a 
large balance of payments surplus and a rigid exchange rate are 
contributing to excess liquidity, over-investment, and asset bubbles 
in real estate and stocks, increasing the risk of a boom/bust cycle. 
 To maintain financial and price stability, the PBOC might be forced 
to slam on the brakes, sharply limiting lending and making it 
difficult for borrowers to roll over debt. 
 
¶3. (SBU) In Seguchi's view, China should avoid such a scenario by 
tightening monetary policy now.  Even though corporate investment is 
increasingly financed through retained earnings, there remains a 
relatively tight link between credit and investment growth, so 
constraining the former will constrain the latter. 
 
WHAT CHINA SHOULD DO 
-------------------- 
 
¶4. (SBU) Seguchi said that the PBOC understands the need for RMB 
appreciation but is politically constrained by concerns about the 
adverse impact on: (1) agricultural competitiveness, given the rapid 
rise in imports due to implementation of China's WTO commitments; 
and (2) processing (export assembly) jobs.  Seguchi said that a 
10-20 percent short-term RMB appreciation would cause numerous 
marginal low-end producers to close factories in China, and the 
sectors they represent (e.g., textiles) are particularly labor 
intensive. 
 
¶5. (SBU) As for interest rates, Seguchi believes that Chinese 
monetary officials are reluctant to raise deposit rates because of 
their concern that banks' inability to assess and manage credit risk 
would continue to lead to a high level of non-performing loans.  As 
a result, monetary authorities want to maintain a large 
intermediation spread to generate sufficient income to provision for 
bad loans. 
 
JAPANESE INVESTMENT IN CHINESE BANKS 
------------------------------------ 
 
¶6. (SBU) Seguchi observed that Japanese banks still remain cautious 
about investing in Chinese banks given the large losses they 
incurred investing in local government international trade and 
investment corporations (ITICs) in previous years that subsequently 
went bankrupt.  The "China hands" who populated Japan's banks at 
that time are now key decision makers, tarnished by this experience 
of learning the hard way that government backing could not be taken 
for granted. 
 
LEARNING FROM JAPAN'S EXPERIENCE 
-------------------------------- 
 
¶7. (SBU) Finatt explained how Chinese officials argue that the 
lesson they draw from Japan's experience in the 1980s is not to 
concede to foreign pressure to let the exchange rate appreciate 
since, in these officials' views, this led to a decade of deflation 
and ultimately had little impact on external imbalances.  Seguchi 
responded that rather than avoiding Japan's mistakes, China risks 
repeating them.  With an open economy, China is unlikely to 
 
BEIJING 00000808  002 OF 002 
 
 
experience high inflation in goods from an undervalued currency and 
excessively loose monetary policy, but will experience asset bubbles 
just like Japan.  Seguchi said that he has communicated to the PBOC 
the importance of understanding Japan's "failure" in the 1980s, 
i.e., Japan over-estimated the impact of currency appreciation on 
monetary conditions, thereby easing monetary policy too much, 
leading to asset bubbles and their subsequent bust and the "lost 
decade" of the 1990s. 
 
REACHING OUT 
------------ 
 
¶8. (SBU) Finatt urged BOJ officials (both current and former) to 
broaden channels for explaining the lessons of Japan's experience to 
China, since they would be the most credible interlocutors on this 
issue.  Seguchi responded that two officials might be particularly 
effective:  (1) BOJ Deputy Governor Horii, and (2) Yasuhisa Shiozaki 
in the Cabinet Office.  Seguchi subsequently spoke with Horii who 
suggested that he and Treasury Under Secretary Adams discuss this 
before Horii comes to China later in the year. 
 
RANDT