VZCZCXRO1470
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0471/01 0560052
ZNR UUUUU ZZH
P 250052Z FEB 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 2468
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 000471 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EAP/CM AND E/YON 
TREASURY FOR OASIA/DOHNER/WINSHIP 
TREASURY ALSO FOR IMFP/SOBEL/CUSHMAN 
NSC FOR LOI 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PREL CH
SUBJECT: ChinaQs NDRC Urges Expanded Fiscal Stimulus, 
Economic Rebalancing, and Exchange Rate Stability 
 
¶1. (SBU) Summary.  Rapidly increasing government spending 
and a decline in tax revenue caused by the economic 
slowdown will drive ChinaQs central and local government 
fiscal deficits to about 2.5 percent of GDP in 2009, 
compared to about 0.5 percent in 2008 and the highest 
level since 2002.  National Development and Reform 
Commission (NDRC) Director General Xu Lin believes China 
can and should expand its fiscal stimulus, as lower 
interest rates are unlikely to spur greater investment 
and exchange rate policy cannot significantly boost 
exports.  Also, China needs to rebalance economic growth 
toward domestic demand-led and services-led growth.  Xu 
said the PeopleQs Bank of China (PBOC), ChinaQs central 
bank, is finding it difficult to convince commercial 
banks to lend to enterprises, given the uncertain 
economic outlook.  At the same time, he claimed the China 
Banking Regulatory Commission (CBRC) is tightening 
prudential requirements due to rising credit risk 
concerns.  Xu believes the central government is likely 
to keep the RMB stable vis-a-vis the U.S. dollar in the 
near term, with only limited volatility.  NDRC is 
encouraging other Chinese regulators to adopt various 
bond market reforms.  Finally, Xu said Chinese officials 
questioned the timing of former U.S. Treasury Secretary 
PaulsonQs remarks on global imbalances in his recent 
interview with the QFinancial TimesQ newspaper.  End 
Summary. 
 
Fiscal Stimulus Boosts Spending ... 
----------------------------------- 
¶2. (SBU) On January 21, NDRC DG Xu told Econ and Finance 
Minister-Counselors that in 2009 ChinaQs central 
government will run a fiscal deficit of approximately RMB 
600 billion (USD 88 billion), while local government 
deficits will total about RMB 200 billion.  This will 
bring the combined 2009 central and local fiscal deficit 
to about 2.5 percent of GDP, compared to the 2008 deficit 
of about 0.5 percent of 2009 GDP.  (Note: Although 
somewhat above 2007-08 levels, the combined 2009 central- 
local deficits as shares of GDP are comparable to 2000-03 
levels.  Also, while local governments technically are 
not permitted to run deficits, in practice they 
frequently do so, in part because their budget 
allocations for succeeding years are based on 
expenditures during current years.  End note.)  Local 
governments will finance one-third of their increased 
economic stimulus spending through deficit financing, 
with the remainder funded through local government 
revenues and bonds issued by local government 
corporations.  The Ministry of Finance (MOF) will issue 
bonds on behalf of local governments, and MOF also may 
allow local governments to issue their own bonds. 
 
¶3. (SBU) The central government generally requires most 
infrastructure projects to have equity capital, but as a 
temporary measure to promote financing of public 
infrastructure development, it allows long-term bank 
loans to constitute up to 40% of the equity.  (Comment: 
Several large state-owned bank representatives previously 
told Finatt that they can increase lending to public 
infrastructure projects prudently while limiting credit 
risks, because most projects require significant equity 
as capital.  It now appears that up to 40% of this 
supposed equity cushion could be the banks' own loans. 
End comment). 
 
... While Tax Revenues Are Falling 
---------------------------------- 
¶4. (SBU) Tax revenues declined 11% year on year (y/y) in 
December and Xu forecasts they will continue to drop in 
the first quarter of 2009, on a y/y basis.  For all of 
2009, he expects tax revenues to grow about eight percent, 
slightly less than nominal GDP growth of 10-12 percent. 
He estimates that tax cuts enacted as part of the fiscal 
stimulus package (i.e.,  making capital goods purchases 
eligible for VAT rebates) will reduce revenues by RMB 300 
billion (one percent of GDP), although the increased VAT 
rebates will provide only  modest support for exporters 
due to falling external demand. 
 
¶5. (SBU) Xu believes China can and should expand the 
fiscal stimulus.  Monetary policy is in a "liquidity 
trap" with lower interest rates unlikely to spur greater 
investment, given current excess capacity and weak 
 
BEIJING 00000471  002 OF 003 
 
 
demand.  Exchange rate policy cannot significantly boost 
exports; even if it could, China needs to rebalance 
economic growth toward domestic demand-led growth.  With 
a low (20-22 percent) debt-to-GDP ratio, China can 
finance bigger deficits without raising concerns about 
the sustainability of public finances.  Xu said the NDRC 
has more worthy projects to finance, but the Ministry of 
Finance (MOF) is reluctant to allow a larger fiscal 
deficit.  Xu suggested that the U.S. should urge other G- 
20 countries with current account surpluses to pursue 
greater fiscal stimulus. 
 
Crisis Promotes Rebalancing 
--------------------------- 
¶6. (SBU) Xu estimates that absent the fiscal stimulus, 
ChinaQs real GDP growth rate for 2009 would fall to five 
percent.  As a result of the financial crisis, he said 
China will intensify its efforts for more domestic 
demand-led and services-led growth.  Shrinking financial 
sectors in developed countries will give manufacturing 
greater relative weight in their economies, and will 
increase competition for ChinaQs manufacturers.  One way 
for China to promote development of services would be to 
eliminate state monopolies and allow private investment 
in some sectors. 
 
Mixed Messages on Bank Lending 
------------------------------ 
¶7. (SBU) While the PeopleQs Bank of China (PBOC) has the 
capability to inject sufficient liquidity into the 
banking system, Xu stated, it may be difficult to 
persuade banks to lend to commercial enterprises, given 
the uncertain economic outlook.  In contrast to efforts 
to boost credit by the PBOC -- which faces political 
pressure from local government officials in the run up to 
this spring's National People's Congress -- the China 
Banking Regulatory Commission (CBRC), concerned about 
rising credit risks, is tightening its prudential 
requirements.  (Note: In a mid-February meeting, however, 
the PBOC told us that CBRC had relaxed somewhat its 
policy on non-performing loans (septel).  End note.) 
 
Exchange Rate Stable 
-------------------- 
¶8. (SBU) Xu believes the Central Government is likely to 
keep the RMB stable vis-a-vis the U.S. dollar in the near 
term, with only limited volatility.  Increasing external 
price competitiveness through depreciation would have 
little impact on exports due to weak external demand.  As 
noted above, he thinks China needs to reorient its 
economy towards more domestic demand-led growth, as the 
financial crisis has made clear it can no longer rely on 
external demand for robust growth.  Given that change in 
the world economy, there would be no reason to risk 
damage to relations with trading partners through 
depreciation, which would bring limited benefit for the 
Chinese economy. 
 
Bond Market Developments 
------------------------ 
¶9. (SBU) Xu said enterprise bonds regulated by the NDRC 
can be traded on both the (PBOC-regulated) interbank bond 
market and the bond exchange regulated by the China 
Securities Regulatory Commission (CSRC).  To increase 
liquidity, the NDRC is encouraging both CSRC and PBOC to 
establish a unified trading platform for both markets, 
which Xu expects will occur this year.  He believes the 
problem with the interbank bond market is that most 
investors are banks, so it does not offer an alternative 
to the banking system.  As there are too few long-term 
institutional investors, NDRC is lobbying the China 
Insurance Regulatory Commission (CIRC) to allow insurance 
companies to hold bonds that do not have bank guarantees. 
Finally, Xu said the NDRC is working to allow foreign 
enterprises to issue RMB bonds; Wal-Mart and General 
Electric are potential candidates. 
 
Paulson Comments on Global Imbalances: Poorly Timed 
--------------------------------------------- ------ 
¶10. (SBU) According to Xu, Chinese officials questioned 
the timing of former U.S. Treasury Secretary PaulsonQs 
remarks on global imbalances in his recent interview with 
the QFinancial TimesQ newspaper.  Xu said some officials 
wondered why he had raised this issue in his final days 
 
BEIJING 00000471  003 OF 003 
 
 
in office.  (Comment:  Paulson had raised similar 
concerns over the course of 2008.  End comment).  Xu 
opined that rather than argue about the causes of the 
financial crisis, officials should to take joint actions 
to ameliorate its impact. 
 
PICCUTA