Governor Zhou Xiaochuan of the People’s Bank of China
March 20, 2006
Editor’s Note: OnMarch 20, Governor Zhou Xiaochuan of the People’s Bank of China participated inthe discussion on exchange rate, China Development Forum sponsored by the Development Research Center of the StateCouncil, and spoke on issues related to China’strade balance and exchange rate. The following is a summary of Governor Zhou’sremarks.
Analysis of China’s Trade Surplus
1. The process ofglobalization, cross-border outsourcing and restructuring of supply chains hasbeen accelerating in recent years, supported by IT revolutionary progress andthe improvement of infrastructures. It now becomes possible to outsource thoseactivities which would be difficult to outsource to foreign countries in thepast.
2. There is a timelag in changing the layout of competitive advantages. Some labor-intensiveproduction activities and services are usually outsourced to developing nationslike China and India,while it will take a certain period of time before the developed countries(where the production cost is high) could create new jobs and develop newexport advantages. Trade imbalance could expand during such a period of timelag.
3. FDI(particularly, of MNCs) has been playing a dominant role in cross-borderoutsourcing into China and in changing the landscape of tradebalance. China has grown into a re-export processingcenter mainly by foreign-funded enterprises, with the supply chainsincreasingly expanded and value-added steadily enlarged. Exchange rateelasticity of such production and trade is fairly small.
4. From 1998 to2004, China’s foreign trade was relatively kept inbalance, with the annual trade surplus averaged between US$20 billion and US$30billion. However, trade surplus suddenly escalated to US$100 billion in 2005,which could be mainly attributed to the slower growth of import in contrast tothe steady growth of export (in 2005, export registered a growth of 28.4 percentwhile import increased by 17.6 percent). The slower growth of import was mainlycaused by the declining import growth of equipments, a factor related to thestructural adjustment of the Chinese economy.
5. FDI(particularly, of the MNCs) has drastically increased their production andsales in China, substituting China’simports. There are numerous foreign branded or foreign-designed products soldin the Chinese market, but a large part of these products have actually beenproduced by the FDI companies in China.
China’s exchange rate regime reform
6. China conducted a successful reform of the RMB exchangerate regime on July 21, 2005, which has won objective and positiveresponses from the international community.
7. The policyanalysis and forecasts conducted before the reform has produced different viewsabout the reform impact, therefore, we need some time to observe and collectdata to assess and confirm the impact of the exchange rate reform on thedomestic economy and employment etc.
8. Six monthsafter the reform, most of the Chinese enterprises have adapted smoothly to thereform after undertaking painful restructuring, however a few sectors sufferedseverely from the exchange rate adjustment. On such a count, we may concludethat the market force could be allowed gradually to play a greater role in thefloating exchange rate.
9. Over the pasteight months, great efforts have been made by Chinato cultivate and develop foreign exchange markets. Trading products wereenriched in the market, risk hedging instruments like forward and swap weredeveloped, market makers and OTC transactions were introduced in the inter-bankforeign exchange market. The Chinese enterprises and financial institutionsneed some time to learn and adapt to the changes in foreign exchange market, sothat they could be in a better position to keep in line with the flotation ofexchange rate.
10. Over the pasteight months, China has decontrolled some unnecessary foreignexchange restrictions. Actions taken in this respect included relaxation ofcontrols imposed on foreign exchange retained and use of foreign exchange undercapital account by the enterprises, facilitation of foreign exchange use byindividuals under current account, and the exercise of applying comprehensivemanagement of foreign exchange positions held by the banks. Through theseefforts, the foreign exchange market will more objectively reflect therelationship between supply and demand of foreign exchange.
GradualistApproach or Shock Therapy?
11. Due to theaccelerating development of globalization, cross-border outsourcing andadjustment of supply chains as mentioned before, it is likely that it will takeseveral years before the global trade could reach a new equilibrium. China as a large developing economy with heavy employmentpressures and a still fragile financial system, could only adopt a gradualistapproach to adjust its economy in a controllable manner.
12. The IMF hasrecently held a conference to discuss the global imbalances, and most of theparticipants believed that it was appropriate to pursue a gradual adjustment,and radical measures could result in unanticipated consequences. Besides, someparticipants suggested that the US has been too slow in making an internaladjustment.
13. Some advisorshave prescribed the “shock therapy” to Russiaand Eastern European countries, but later on this was described as “shock withno therapy”. We should be cautious to offer the same prescription again, so asnot to have credibility jeopardized. China will only consider to take thegradualist reform approach that wins the trust of the masses of the Chinesepeople, rather than a “shock”, not to mention that the US has not taken thelead to use “shock” to adjust its imbalances.
Global Imbalancesand the Role of Exchange Rate
14. The Chinesegovernment has already started to apply a mix of policy measures, includingexpanding domestic demand, lowering down saving rate, opening up the market,floating the exchange rate and increasing import, so as to improve the balanceof payments. With the implementation of these policy measures, the PBCanticipates that it needs a time span of 2-3 years to achieve an approximatetrade balance. However, what is worrisome is that, according to the analysis bythe Chinese economists, even China basically realized a global trade balance,the United States might still incur large trade deficits and it would still bevery difficult to achieve a bilateral trade balance between China and the US.So the ball would be actually not in China’s court.
15. The US and China should make joint efforts to address the tradeimbalance between the two countries. When the Chinese government has beenmaking an efforts as mentioned above trying to relieve the problem, complaintsare also heard that the US has been slow in taking concrete measuresto reduce its twin deficits and improve saving rate.
16. Some US economists assume that the exchange rate is the keyto fixing the trade imbalance, while on the Chinese side there are economistsfrom different schools and some also tend to believe in this assumption.However, such assumption failed in statistical test by using the trade data andreal effective exchange rate recorded in Chinaover the years. Besides, empirical knowledge about many other countries alsodoes not support such a judgment. Therefore, we should be cautious to relysolely and excessively on exchange rate function to realize current accountbalance.
17. According tothe Articles of Agreement of the IMF, “member countries shall have the right tochoose exchange rate regime, either free floating, managed floating or fixedexchange rate, at their own discretion”. In this sense, there exists no such anexchange rate regime that can be labeled as “manipulating exchange rate”. China’s gradual shift from a relatively fixed arrangementto an exchange rate regime with greater flexibility in line with the needs ofeconomic reform and opening up has won extensive support from the worldcommunity, and those criticisms wrongly accused this action as “manipulatingexchange rate” will not be widely accepted.
18. China’s trade balance should be assessed within a timeframework of a number of years, not of a single year. And relevant statisticsdo not support the view that China gains trade advantages from the exchangerate. Japan has recorded large trade surpluscontinuously for many years, and yet the notion that Yen exchange rate has beenmanipulated is not accepted.
The Duality BetweenSavings Gap and Trade Imbalances
19. Savings gapequals to the difference between savings and investment, and trade imbalanceequals to the difference between export and import. Macroeconomics describesthe duality relationship between them. Excess savings will result in tradesurplus, and vice versa. Therefore, it is important to view the problem oftrade imbalance from the perspective of savings.
20. There are manydifferent reasons behind the high saving rate in China.Some of them are related to the economic transition process while others aremore associated with the social, cultural and traditional characteristics.Besides, the crowding out effect of FDI on domestic investment is likely tofurther increase excess savings in China.
21. The Chinesegovernment now works on a broader perspective as well as more policyinitiatives and strategies consistent with the national condition to expandinternal demand, particularly the consumption demand. It also needs a certainperiod of time to realize such an adjustment.
22. The highsaving rate and large stock of foreign reserves in Asiaare related to the Asian financial crisis. Many Asians complained some hedgefunds from the US during the crisis, and were alsodisappointed with the insufficient role and slow policy responses of the IMF tothe crisis. These factors have made countries and households in Asia to rely more on their own to prevent risks.
23. Saving rate inthe US has gone to the other extreme. Both the US and Chinaneed to make efforts to level their domestic demand and saving rate, otherwise,it would be difficult to resolve the trade imbalance. We are of the view that acertain priority should be given to orchestrated structural adjustments, andthe function of exchange rate should not be too much expected.
Foreign ExchangeReserves
24. After the exchangerate regime reform on July 21, 2005, there will be a timelag before the reform could have an expected impact on the development ofcurrent account balance and FDI in China, and thespeculative factors are also unlikely to leave right away. Under the managedfloating exchange rate regime, the PBC will gradually reduce its managing rolein the foreign exchange market in line with the situation, which will lead to aslower growth of the foreign reserves.
25. After theAsian financial crisis, there emerged some new views and discussions withregard to setting a higher level as the rational foreign exchange reserveholding. These developments are also related to the severe shocks experiencedand lessons learned by the crisis hit countries.
26. If twocomparable countries have different sizes of external debts and differentstocks of FDI, their foreign reserves should not be held at the same level.External debts need to be repaid, and FDI entails dividend remittances and theymay even withdraw. Besides, some speculative hot money, if existed, could alsoseize the opportunity to exit at any time. All these factors bear someinfluences on the quantitative level of foreign reserve holding. If measured byper capita level, China’s foreign reserves are not high.
WTO Rules
27.The WTOmechanism has established game rules on a multilateral basis that enable allmembers to win; it is also a win-win game for Chinaand the US. Although members may dispute regardingsome imbalances, it at least gives a room for the differences to be resolvedthrough negotiations. If anybody designs a lose-lose game for US and China, it hurts both countries, and designer himself willbe in a dilemma whether the game should go on or not. Thus we have to chooseand play a win-win game of free trade and anti-protectionism.
