VZCZCXRO4525
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0829/01 0882324
ZNR UUUUU ZZH
P 292324Z MAR 09 ZDK-2
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 3154
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 06 BEIJING 000829 
 
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: China: Fiscal Stimulus and Monetary Loosening 
Keep Economy Growing 
 
Ref: a) Beijing 0728 
b) 2/25 Loevinger-Treasury email 
c) 08 Beijing 4665 
 
BEIJING 00000829  001.2 OF 006 
 
 
Summary 
------- 
¶1. (SBU) Many Chinese economic contacts remain optimistic 
China can attain eight percent GDP growth in 2009, 
although some local and foreign economists recently have 
lowered their forecasts to 6-7 percent or even lower. 
The World Bank expects no contribution to real GDP growth 
from net exports, with no other significant potential 
growth sources apparent.  Most interlocutors view the 
Government's fiscal stimulus measures positively, 
estimating they will add one percent to GDP growth in 
2009 and 2010, while the rising fiscal deficit (to three 
percent of GDP in 2009) does not raise concerns about the 
sustainability of public finances.  Government efforts to 
rebalance the economy away from exports in favor of 
domestic consumption are welcome, but some question their 
effectiveness and adequacy.  China's "appropriately 
loose" monetary policy since October has led to a larger 
than expected surge in new credit, in particular to 
finance stimulus projects, with some concern among 
regulators that this could sow the seeds for future 
growth in non-performing loans.  See Comments in 
paragraphs 22-24.  End Summary. 
 
¶2. (SBU) During a February 25-27 visit to Beijing, U.S. 
Treasury DAS Robert Dohner discussed economic and 
financial issues with the following officials and 
economists: Vice Chairman Ma Xiaohe of the Academy of 
Macroeconomic Research, National Development and Reform 
Commission (NDRC); Director General (DG) Zheng Xiaosong, 
International Department, Ministry of Finance (MOF); DG 
Liu Chunhang, Research Department, China Banking 
Regulatory Commission (CBRC); DG Xia Bin, Development 
Research Center (DRC); DG Zhang Xin, Financial Stability 
Department, People's Bank of China (PBOC); DG Yin Yong, 
Reserve Management Department, State Administration of 
Foreign Exchange (SAFE); DG Shi Gang,  Department of 
National Economy, NDRC; Managing Director Arthur Kroeber, 
Dragonomics; Resident Representative Tarhan Feyzioglu, 
International Monetary Fund; Chief Economist Shen Minggao, 
"Caijing" magazine; and Country Director David Dollar, 
World Bank.  Comments by SAFE DG Yin and MOF DG Zheng 
were reported separately in refs a and b. 
 
Eight Percent GDP Growth Still Possible? 
---------------------------------------- 
¶3. (SBU) As late as December 2008, most local and foreign 
economists believed China would be able to achieve about 
eight percent GDP growth in 2009, albeit with "big risks 
on the downside" (ref c).  Now, however, while still more 
optimistic than foreign observers, our Chinese contacts 
are noticeably less unanimous and less positive.  At the 
top of the optimism scale was NDRC DG Shi Gang, who said 
there remains "great room for growth" in China.  Capital 
and labor are plentiful, prices of imported commodities 
are falling, and China still offers an attractive and 
stable investment climate.  While the government's policy 
measures will need time to have an impact, maintaining 
eight percent GDP growth in 2009 is still possible, 
especially if the U.S. stimulus package is effective 
quickly.  While growth will be slower than 2008, Shi said 
the recovery will begin in the second half of 2009.  DRC 
DG Xia also thought eight percent growth is likely, 
although he said the focus on this number is based on the 
need to maintain social stability.  Xia agreed that China 
pins considerable hope on a relatively rapid U.S. 
recovery to support its own growth, although "personally" 
he is not optimistic about the near-term prospects for 
the United States. 
 
¶4. (SBU) The IMF, like many others, has lowered its 
forecast for China, and Resident Representative Feyzioglu 
said this is the first time he has seen such "tremendous" 
variations in views about growth in China.  He estimates 
2009 GDP growth will reach 6.5 percent, although eight 
percent remains possible "if China is lucky."  Despite 
the decline in the price of imported commodities, China's 
trade surplus may increase in real terms in 2009, and it 
definitely will grow in nominal terms, as China still 
enjoys a competitive advantage in many light industry 
 
BEIJING 00000829  002 OF 006 
 
 
sectors and has been gaining market share and opening new 
markets in Latin America, Europe, and elsewhere. 
 
¶5. (SBU) The World Bank's Dollar said he is "very 
worried" about China's growth prospects for 2009.  He 
expects no contribution to real GDP growth from net 
exports, and no other significant potential growth 
sources are apparent.  Investment will be unable to 
compensate, as manufacturing investment (about one-third 
of total investment) has stopped; real estate, about one- 
fourth, is weak; and infrastructure, which had been about 
twenty percent, is unlikely to increase enough to offset 
the other declines.  (Note: In its "Quarterly Update" 
report issued March 18, the Bank lowered its 2009 GDP 
growth forecast to 6.5 percent.  End note.) 
 
Proliferating Pessimism 
----------------------- 
¶6. (SBU) Three other economists provided worrisome views. 
Kroeber of Dragonomics said underlying conditions have 
worsened in recent months.  In 2009, exports will decline 
for the first time in memory, forcing a severe downward 
wage adjustment in the export sector given China's 
exceptionally flexible wages and leading to real exchange 
rate depreciation (based on relative unit labor costs). 
As a result, China's exports will decline less than those 
of other regional economies; with lower commodity prices 
reducing imports, China's trade surplus will grow even as 
exports decline.  Kroeber opined that China's growth is 
not helpful to other countries in the region, because 
even as China "gets its own house in order" it will 
adversely impact the growth of its neighbors. 
 
¶7. (SBU) Shen of "Caijing" magazine, noting a tendency 
for the aggregate weighted average of provincial GDP 
growth rates to exceed by several points the national GDP 
growth rate, noted that local governments are projecting 
"only" about seven percent real growth for 2009.   Shen 
believes that "fast" growth (nine percent) this year 
under the current economic model would lead to 
"disaster," due to huge over-capacity, and even eight 
percent growth would not necessarily lead to social 
stability, because that growth would benefit upstream 
rather than more labor intensive downstream sectors. 
NDRC's Ma observed that China's domestic consumers cannot 
compensate for the slump in export demand, even if the 
government asks them to "show their patriotism" by buying 
more goods.  As a result, excess productive capacity will 
mean fewer jobs, weak growth in wages, household income, 
and consumption. 
 
Stimulus is Working? 
-------------------- 
¶8. (SBU) Chinese economists were positive about the 
Government's efforts to stimulate the economy, including 
a fiscal stimulus (which will increase the budget deficit 
in 2009 from 0.5 percent of GDP to at least 3 percent), 
looser monetary policy, and ten sectoral consolidation 
plans.  According to NDRC's Shi and DRC's Xia, the new 
policies are intended concurrently to boost growth, 
promote economic restructuring, upgrade technology levels, 
and create or preserve jobs.  Xia believes the fiscal 
package demonstrates that the Government has both the 
determination and the means to address the economic 
situation.  Underpinning that package are literally 
hundreds of policy changes issued by the State Council 
and other ministries to boost demand and consumption. 
 
¶9. (SBU) NDRC's Ma estimated the central government's 
fiscal stimulus would add roughly one percent to GDP 
growth in 2009 and 2010.  In addition, thus far 28 of 31 
provinces have initiated their own stimulus plans. 
Central and local authorities have taken various other 
steps to stimulate domestic consumption, including 
subsidies for household appliance and automobile 
purchases by rural residents, consumer vouchers, and 
provincial and local tax benefits to encourage property 
purchases.  Ma said these stimulus measures seem to be 
having some effect, although it was not yet clear whether 
the economy has turned around. 
 
¶10. (SBU) Both the World Bank and the IMF have welcomed 
the stimulus measures.  Dollar said there is "a lot of 
good stuff."  Some large projects slowed in 2008 due to 
 
BEIJING 00000829  003.2 OF 006 
 
 
economic over-heating can quickly and easily be restarted. 
While domestic content regulations limit access for 
foreign firms in some sectors, many other infrastructure 
projects are open, although requirements vary.  Feyzioglu 
said he was impressed by the Government's rapid reaction 
to the crisis, noting that a higher near-term fiscal 
deficit, even as much as five percent of GDP, would not 
be a concern.  Shen of "Caijing" believes the Government 
wants to keep the fiscal deficit under three percent of 
GDP, although if local government borrowing were made 
explicit China's actual deficit already would be "huge." 
(Comment: Some Chinese officials appear focused on 
limiting the fiscal deficit to three percent of GDP, 
which MOF officials have characterized as a prudent 
international threshold.  Ironically, this came from 
Europe's Maastricht Treaty, which was based on Europe's 
much lower potential growth rates.  Most Western analysts 
believe China could prudently run a much larger deficit. 
End Comment.) 
 
¶11. (SBU) According to Shen of "Caijing," provincial and 
local governments are optimistic about 2009 but complain 
of insufficient funding.  Only the central government is 
permitted to issue bonds, and during the previous crisis 
(late-1990s) it did so on behalf of the local governments, 
which never repaid Beijing.  Nonetheless, the central 
government is issuing RMB 200 billion in bonds for local 
use, which constitutes about forty percent of the local 
share of fiscal stimulus financing.  Shen also believes 
the stimulus package is overly focused on upstream 
industries and primarily will benefit state-owned 
enterprises, so any supplemental stimulus package should 
focus more on downstream industries. 
 
Rebalancing: Old Advice, New Urgency 
------------------------------------ 
¶12. (SBU) DRC's Xia said China will "do everything 
possible" to rebalance from an export-driven economy 
toward a more consumption-driven model, something which 
Dollar said the World Bank has been advising China to do 
for years.  The Bank also is encouraging China to further 
liberalize trade and investment in services.  IMF's 
Feyzioglu noted several Government measures to boost 
consumption, such as the rural voucher system and a huge 
rise in health care expenditures.  He recommended 
accelerated reform of the pension and health care systems 
to boost consumption, together with an increase in the 
minimum taxable income threshold.  NDRC's Ma believes 
China's per capita income remains too low for "mass 
consumption" to take hold. 
 
¶13. (SBU) Dragonomics' Kroeber questioned the 
Government's willingness to grapple with the need for 
structural change, as well as its ability to find a 
substitute for external demand and an "alternative 
productivity driver" after the short-term effects of the 
fiscal stimulus have worn off.  He detects little 
determination to push through structural reforms that 
would reduce reliance on industry and support growth of 
services.  Shen of "Caijing" observed that an increase in 
consumption would benefit both China and the world, but 
the "Chinese Government has not done anything 
significant" in this regard.  This, he said, is due in 
part to conflict between the central and local 
governments; the latter only care about investment, not 
consumption, so they do not view tax cuts and social 
welfare spending as particularly useful.  (Note:  Some 
analysts argue that the fact that manufacturing is taxed 
more heavily than services may encourage government 
officials to promote manufacturing investment). 
 
Unemployment Worries 
-------------------- 
¶14. (SBU) China's rising unemployment problem plays a 
prominent role in most discussions of economic policies. 
Kroeber of Dragonomics said current measures will get 
"enough" people employed, meaning that "stability" will 
not become a problem.  World Bank's Dollar said real 
wages are fairly flexible in China, and wage levels have 
been declining since the onset of the crisis.  He 
believes manufacturing employment in China may have 
peaked permanently, and in any event has not been a 
significant net job creator in recent years.  According 
to Shen of "Caijing," about 20 million migrant workers 
 
BEIJING 00000829  004.2 OF 006 
 
 
already have lost their jobs, with each one percent 
decline in exports costing another 200,000 migrant jobs. 
He believes the Government has taken little real action, 
although it worries about negative social consequences 
(crime).  Shen also argues that raising the 
competitiveness of Chinese industries, a key component of 
the ten-sector revitalization plan, may conflict with the 
need to increase employment; in the long term, however, 
both are essential.  Any loss of skilled labor during the 
crisis would affect companies' efficiency in the long 
term, so the Government wants to minimize lay-offs. 
 
Monetary Policy: Appropriately Loose 
------------------------------------ 
¶15. (SBU) CBRC DG Liu outlined monetary policy measures 
taken since last year to bolster the economy.  In October 
2008, the PBOC lifted the lending quota, which had 
suppressed financing needs, leading to the lending surge 
since November (PBOC also reduced reserve requirements, 
its sterilization operations, and interest paid on excess 
reserves).  Although January credit levels normally are 
inflated, as many projects are negotiated at year end, 
the stimulus package provided a further boost. 
Regulators are monitoring closely to ensure lending 
addresses official priorities: government projects, 
including infrastructure, housing, and "green" 
investments, as well as small and medium-sized 
enterprises, which Liu said the banks tend to avoid.  Liu 
said banks will have no difficulty meeting lending needs 
for fiscal stimulus projects; encouraging Chinese banks 
to lend is not difficult, as the problem always has been 
holding them back.  The Government has not instructed 
banks to increase lending by a certain amount. 
 
¶16. (SBU) Liu said new lending surged sharply in January 
to RMB 1.6 trillion, of which about 600 billion was for 
discounting bills, 600 billion for long-term loans, and 
400 billion for short-term loans.  Liu believes "most of 
these loans are real" (for new projects).  Other reasons 
for the huge increase include the refinancing of high 
interest rate loans that had been secured from non-bank 
financial institutions (both formal and informal) during 
times when the credit quota meant banks could not fulfill 
demand.  Liu said there was no way to discern if some of 
the new credit was used for stock market purchases, but 
CBRC was trying to minimize such "leakage." 
 
¶17. (SBU) NDRC DG Shi described China's current monetary 
policy as "appropriately loose," supporting Government 
policies to increase investment and promote private 
sector lending, and said commercial banks are willing to 
support central Government projects.  PBOC DG Zhang said 
he was not surprised by the huge January lending, but is 
concerned that more than one-third of the new credit was 
for discounting bills, in which, given the low lending 
rates, there are arbitrage opportunities and corporate 
borrowers can earn a higher rate in corporate time 
deposits.  Shen of "Caijing" observed that the Government 
wants to ensure its control of the financial system and 
maintain control of credit growth, so the pace of reform 
will slow, especially with regard to the financial sector, 
interest rate liberalization, and opening of the sector 
to private investment.  Feyzioglu said the IMF has 
recommended that China raise deposit rates, which the 
government resists because that would lower bank margins. 
He said very low deposit rates mean the opportunity cost 
of investing also is very low, so enterprises tend to 
invest a lot. 
 
2009 Will Test China's Banks 
---------------------------- 
¶18. (SBU) CBRC DG Liu said the global crisis has not had 
any substantial direct impact on China's banks, but "the 
indirect impact is coming".  Thus far, non-performing 
loan (NPL) ratios have not increased significantly; in 
2008, the stock of NPLs actually declined by one-third 
(to about 2.3 percent, the lowest ever) due largely to 
Agricultural Bank of China restructuring (which moved 
some NPLs off of ABC's and the banking sector's balance 
sheets), although the Sichuan earthquake in May caused 
NPLs to rise.  China's banks are well-capitalized: 204 of 
205 commercial banks meet capital adequacy requirements, 
with an aggregate level near twelve percent.  In 2008, 
regulators increased provisioning requirements against 
 
BEIJING 00000829  005 OF 006 
 
 
bad loans, and the coverage ratio is now about 117 
percent.  Bank profits in 2008 rose thirty percent to a 
record high, due to China's very strong economic 
fundamentals. 
 
¶19. (SBU) Nonetheless, said Liu, "stress is coming" and 
"2009 will be a true test of risk management and 
corporate governance in the banks."  With GDP growth 
falling Liu expects NPLs to increase.  In a partial 
relaxation of policy (and acknowledgement of realities), 
CBRC is asking banks to adhere to prudential principles 
and maintain their NPL ratios, but their NPL stocks will 
be permitted to grow.  CBRC also is watching closely to 
ensure there is no "mucking around with the data," and 
Liu believes regulators will know quickly if problems are 
developing.  Local governments are pushing for more 
lending, prompting complaints from the banks, but so far 
there have been no "breakdowns" and risk management in 
the big banks is "holding up well."  The smaller and 
regional banks are under more pressure due to decline in 
real estate prices, so they are not as "robust." 
According to IMF's Feyzioglu, NPL ratios may rise to 4-5 
percent, which the large banks can handle.  The small 
city banks, however, have been hurt by real estate and 
export slumps, and China has no explicit deposit 
insurance. 
 
¶20. (SBU) DG Liu said one of the highest risk sectors is 
real estate, although China's "bubble" is not as large as 
earlier ones in Japan and the U.S.  The government 
promptly issued new regulations and guidance at the peak 
of the bubble (mid-2007), so mortgage NPLs (about one 
percent) have not increased.  Regulators and lenders are 
"sticking to the rules," although the minimum housing 
down payment has been lowered to 20 percent to encourage 
sales.  Despite a serious drop in sales volume in 2008, 
Liu believes China's real estate prices need to decline 
further. 
 
Foreign Banks Face Different Issues 
----------------------------------- 
¶21. (SBU) DG Liu noted that last fall concerns about 
counterparty risk temporarily made it difficult for 
foreign banks in China to access RMB liquidity, but the 
CBRC, SAFE, and PBOC acted quickly to create a new 
liquidity facility.  PBOC DG Zhang said foreign banks 
encountering liquidity difficulties can borrow from the 
PBOC with collateral, or can obtain capital from overseas. 
DG Liu observed that some of the foreign banks had loan 
to deposit ratios of up to 300 percent, far above the 
CBRC limit of 75 percent, but the regulator "tolerated 
this behavior" and extended a five-year grace period for 
compliance.  That the foreign banks now have declining 
loan portfolios in China is due to contraction of their 
parent banks, which now are "reconsidering their business 
model." 
 
Comment 
------- 
¶22. (SBU) Heading into the second quarter of 2009, the 
three primary macroeconomic questions for China remain: 1) 
will China's domestic consumption grow so it makes a 
bigger contribution to global demand; 2) will the surge 
in bank lending translate into sustained growth; and 3) 
will the government cut spending when revenues come in 
under budget.  First, while the sharp drop in exports has 
helped catalyze a consensus on the need to promote more 
"home-grown" domestic demand-led growth, few economists 
expect a meaningful decline in China's current account 
surplus (as a percent of GDP), and some expect an 
increase.  Thus, as most analysts expect net exports to 
make no contribution to GDP growth, and even if China is 
able to meet its growth target, its net contribution to 
aggregate global demand is expected to be only slightly 
positive, at a time when global demand is collapsing. 
 
¶23. (SBU) Regarding bank lending, while there has been 
significant official "jawboning" of banks to increase 
lending, there is no evidence of official enforcement 
mechanisms should lending growth fall below desired 
levels.  In contrast, when the government was concerned 
about overheating, banks with excessively high loan 
growth rates were required to purchase "penalty bonds" 
with below market interest rates.  Rather than being 
 
BEIJING 00000829  006 OF 006 
 
 
caused by excessive moral suasion, the recent surge in 
bank lending appears to be due mainly to a rational 
commercial response to the lifting of a binding credit 
quota as well as uncertainty about when it might be re- 
imposed, combined with a large increase in liquidity (due 
to reduced reserve requirements and less sterilization) 
and a lowering of the interest rate on excess reserves. 
 
¶24. (SBU) Finally, Western and Chinese officials and 
economists tend to have different concepts of "fiscal 
stimulus."  While the former tend to think of a stimulus 
in terms of the public sector's contribution to aggregate 
demand (usually due to an increase in the public sector's 
deficit), Chinese economists tend to focus on increased 
spending even if it is financed through higher taxes 
(which subtract from private sector demand).  As a result, 
Chinese officials can talk about a RMB four trillion 
"stimulus" (14 percent of GDP) with only a 2.5 percent 
increase in the fiscal deficit.  (Though given excess 
capacity and an uncertain labor market, the government's 
propensity to save is likely to be less than that of 
households and corporations.  As a result, tax-funded 
spending could still contribute to aggregate demand). 
 
PICCUTA