VZCZCXRO1754
PP RUEHCHI RUEHCN RUEHDT RUEHGH RUEHHM RUEHVC
DE RUEHHK #0421/01 0650931
ZNR UUUUU ZZH
P 060931Z MAR 09
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 7067
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS PRIORITY
RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 HONG KONG 000421 
 
SIPDIS 
 
STATE FOR EAP/CM AND EEB/OMA, TREASURY FOR OASIA 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD HK CH
SUBJECT: FAITH IN CHINESE STIMULUS, DOUBTS ABOUT DEMAND 
 
¶1. Summary: Hong Kong analysts, financial officials and 
bankers generally trust that China's fiscal and monetary 
stimuli will help prop up Chinese GDP growth in 2009 despite 
rapidly collapsing exports.  Most senior Chinese officials 
understand that declining exports reflect evaporating foreign 
demand, not loss of competitiveness vis--vis other 
exporters.  Although China has unveiled some symbolic 
concessions to exporters, most analysts agreed that 
devaluation of the RMB is unlikely in the near term. 
Reorienting the Chinese economy away from export-related 
manufacturing and toward additional domestic consumption will 
take years; the necessary physical and social infrastructure 
is still underdeveloped.  End Summary. 
 
¶2.  U.S. Treasury officials from Washington, Embassy Beijing 
Financial Minister Counselor and U.S. Consulate General Hong 
Kong Economic Unit Chief met with Hong Kong-based analysts, 
bankers, and Hong Kong financial officials February 20-24 to 
discuss Chinese macroeconomic performance, social stability, 
banking sector developments and other policy issues, 
including Hong Kong government preparations for the London 
G-20 meeting in April (reported septel).  All of the above 
USG participants have cleared this cable. 
 
Stimulus Will Boost 2009 Growth... 
================================== 
 
¶3.  Local economic analysts generally support the Chinese 
Central government's approach to fiscal stimulus.  HSBC 
Economist Fred Neumann foresees Chinese real estate 
transaction volumes increasing and believes the destocking 
process blamed for plummeting regional exports to China is 
almost complete.  Among the most optimistic of local 
China-watchers, HSBC expects Chinese GDP growth to exceed 
eight percent by the end of 2009. 
 
But Then What? 
============== 
 
¶4.  Several of our interlocutors worried, however, that the 
stimulus package impact on GDP growth would fade by the 
middle of 2010, well before the Chinese economy is able to 
reorient its economy away from manufacturing for export 
toward domestic consumption.  The Chinese government can 
provide more fiscal stimulus without raising concerns about 
its creditworthiness, said Goldman Sachs economist Michael 
Buchanan, but policymakers are reluctant to allow their 
budget deficit to exceed three percent of GDP.  Goldman Sachs 
Managing Director Fred Hu disagreed, and argued that the 
Chinese leadership will not worry about additional deficit 
spending, as long they can find reasonable programs to fund. 
Asianomics CEO Jim Walker noted that China's strong fiscal 
position allows it to undertake additional government 
spending, but with government revenues dependent on taxes on 
real estate transactions, the value added tax (VAT) and 
corporate taxes, he predicted Chinese government income will 
fall sharply this year.  (Note: Chinese Ministry of Finance 
officials told Finatt that three percent of GDP is an 
"international standard" for a prudent budget deficit.  This 
assertion appears to be drawn directly from Europe's 
Maastricht Treaty, which was based on Europe's much lower 
potential growth rate, higher real interest rates, and higher 
existing debt to GDP ratios.  China could in fact run much 
larger deficits, particularly during a severe cyclical 
downturn and still maintain sustainable public services.  End 
Note.) 
 
Increasing Bank Lending Key to Stimulus 
======================================= 
 
¶5.  Goldman Sachs Managing Director Roy Ramos believes recent 
strong growth in lending has been driven more by government 
moral suasion than by productive investment opportunities. 
As much as 40 percent of new loans represent short term 
borrowing, taking advantage of the sharp drop in lending 
rates on discounted bills to invest in higher CD deposit 
rates or the Chinese stock markets, Ramos said.  Another 
10-20 percent reflects the refinancing of high-cost borrowing 
from non-bank financial institutions during the period of 
binding credit quotas.  Just 40-50 percent of new loans are 
financing productive infrastructure investments or operating 
capital expenses, he remarked. 
 
¶6.  Chinese banks are getting mixed messages from the Chinese 
Banking Regulatory Commission (CBRC): lend more, but avoid 
bad debt.  The CBRC does not appear to be directing loans to 
particular firms or imposing penalties if loan growth falls 
below target.  CBRC pressure is forcing the smaller banks to 
 
HONG KONG 00000421  002 OF 003 
 
 
face more difficult lending choices.  Partially shut out of 
infrastructure and State-owned enterprise lending, they must 
turn to the small and medium enterprises (SMEs) to make 
loans.  Goldman Sachs estimates that as many as 20 percent of 
loans to Chinese SMEs are at risk of falling into 
non-performing status, based on their earnings before 
interest, taxes, depreciation and amortization (EBITDA).  As 
bad as that is, said Ramos, China is one of the better 
performers in the region.  By the same measure, 35-45 percent 
of loans to Taiwan SMEs risk becoming non-performing, he 
claimed. 
 
¶7.  (Note: These views are at odds with what Chinese 
interlocutors tell Embassy Beijing Financial MinCouns.  Most 
mainland Chinese bankers, regulators, and analysts believe 
the sharp increase in lending during the first two months of 
2009 is not due to moral suasion, but is a commercially 
rational response to the increase in liquidity resulting 
from: the decrease in reserve requirements; sales of 
sterilization bonds; withdrawal of government deposits at the 
central bank; interest rate cuts on excess reserves in the 
central bank; and, the lifting of binding credit quotas. 
Flush with liquidity, and uncertain when credit quotas will 
again restrict lending, banks have rushed to extend credit to 
borrowers with implicit central government guarantees, such 
as state-owned enterprises and National Development and 
Reform Commission-approved infrastructure projects.  End 
Note.) 
 
Chinese Leaders Won't Try to Protect Exports 
============================================ 
 
¶8.  Senior Chinese officials understand that China's rapidly 
falling exports are a function of collapsing external demand, 
not a lack of price competitiveness, said Goldman Sachs' Hu. 
The government is likely to pursue symbolic measures to try 
to cushion the blow for exporters, but it is clearly 
impossible to try to maintain exports when Western demand has 
collapsed, he said.  The Chinese authorities have been 
adopting measures to drive low value-added export production 
out of the Pearl River and Yangtze Delta regions for some 
time already, said Simon Ogus, CEO of DGS Asia.  The collapse 
in external demand will just speed the process, he said. 
While some have called for China to depreciate the RMB, doing 
so would not help exporters, said Royal Bank of Scotland 
(RBS) economist Ben Simpfendorfer, and would encourage 
capital flight.  Others were not so confident.  HSBC's 
Neumann and Asianomics' Walker both predicted the RMB would 
lose value against the U.S. dollar later this year as the 
Chinese authorities attempt to offset real effective exchange 
rate appreciation vis--vis regional currencies. 
 
¶9.  The declining fortunes of the export sector would be less 
of a concern if there weren't millions of migrant workers 
forced out of work, said Bank of China International (BOCI) 
Managing Director Anthony Lok.  With estimates of up to 35 
million unemployed by the end of 2009, the Chinese 
authorities are worried that the potential for unrest is 
increasing, said Lok.  But RBS's Simpfendorfer disagreed, 
noting that migrant worker demonstrations in Guangdong over 
the past several months have been directed at factory owners, 
not the government.  With large numbers of migrant workers 
scattered throughout their home provinces after the Lunar New 
Year holiday, it is difficult for them to organize.  In any 
event, food prices have traditionally been more likely than 
unemployment to spark unrest directed at the government, he 
said.  The central government will increase security around 
key events such as the National People's Congress (NPC) and 
other important anniversaries, said Goldman Sachs economist 
Helen Qiao.  She added that the burden of providing jobs, 
training or other activities for unemployed migrants is 
likely to fall on local governments. 
 
Restructuring before Rebalancing 
================================ 
 
¶10.  Analysts and observers agree that China cannot rely on a 
rapid rebound of external demand to save the export sector. 
The Chinese economy has been structurally misaligned for many 
years, said Asianomics' Walker.  Low interest rates and an 
undervalued exchange rate have encouraged massive investment 
in capital intensive export manufacturing and a lack of 
production for the domestic market.  Low rates of domestic 
consumption have been held down by unnaturally high rates of 
investment and the dismantling of the Chinese social safety 
net, he said.  Boosting domestic consumption in China will 
take years, said Simpfendorfer, and will have to begin with 
increasing government spending on health and education. 
 
HONG KONG 00000421  003 OF 003 
 
 
 
¶11.  BOCI's Lok agreed, adding that inadequate distribution 
networks make increasing domestic demand more challenging. 
He noted that many exporters benefit from VAT rebates on 
imported components, making production for the domestic 
market more costly.  DGS' Ogus added that the large number of 
Chinese companies dependent on the export sector makes it 
difficult to increase domestic consumption during an economic 
downturn.  Anticipated and actual job losses in this 
important sector will reduce incentives to consume more. 
Goldman Sachs' Qiao dismissed Chinese government "electronics 
for the countryside" program as ineffective, subject to 
corruption and manipulation, and unlikely to produce any real 
increases in rural consumption.  Spending on health and 
social security is just one percent of the central 
government's stimulus program, she said.  As long as the 
Chinese consumers are still worried about the cost of 
education, health care and retirement, they will be unwilling 
to significantly increase spending. 
DONOVAN