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### Viewing cable 06HONGKONG1839, CHINA CURRENCY AND MACRO POLICY: IMF'S

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
06HONGKONG1839 | 2006-05-03 11:01 | 2011-08-23 00:00 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Consulate Hong Kong

`

    VZCZCXRO2135
    PP RUEHCN RUEHGH
    DE RUEHHK #1839/01 1231101
    ZNR UUUUU ZZH
    P 031101Z MAY 06
    FM AMCONSUL HONG KONG
    TO RUEHC/SECSTATE WASHDC PRIORITY 6474
    INFO RUEHOO/CHINA POSTS COLLECTIVE
    RUEATRS/DEPT OF TREASURY WASHDC
    RUCPDOC/USDOC WASHDC

` `

    UNCLAS SECTION 01 OF 02 HONG KONG 001839

    SIPDIS

    SENSITIVE
    SIPDIS

    STATE FOR EAP/CM AND EB
    TREASURY FOR OASIA GKOEPKE
    STATE PASS USTR
    USDOC FOR 4420

    E.O. 12958: N/A
    TAGS: EFIN ECON PGOV HK CH
    SUBJECT: CHINA CURRENCY AND MACRO POLICY: IMF'S
    PRESCRIPTIVE APPROACH OVERLOOKED BY MEDIA

    (U) THIS DOCUMENT IS SENSITIVE BUT UNCLASSIFIED.  PLEASE
    PROTECT ACCORDINGLY.  NOT FOR RELEASE OUTSIDE U.S. GOVERNMENT
    CHANNELS.  NOT FOR INTERNET PUBLICATION.

    INTRODUCTION/SUMMARY
    --------------------

    ¶1. (SBU) Media coverage of the International Monetary Fund's
    (IMF) May 2 unveiling in Hong Kong of its Asia-Pacific
    regional outlook is based primarily on an advance press
    release and does not capture the prescriptive approach put
    forward at the event with regard to China's currency and
    macroeconomic policies.  The IMF used the event to call on
    China to (a) exercise greater currency flexibility and (b) to
    increase spending on education, health care, and retirement
    as a way to reduce the need for "precautionary savings."  END
    INTRODUCTION/SUMMARY

    PRESENTATION IN HONG KONG
    -------------------------

    ¶2. (SBU) On May 2 in Hong Kong, the IMF Deputy Director for
    Asia, Wanda Tseng, presented the latest Regional Economic
    Outlook (REO) for the Asia-Pacific region.  A full copy of
    the REO is available on www.imf.org.  The purpose of this
    message is not to summarize the full report but to highlight
    a number of China- and Hong Kong-related comments made at the
    event that are likely to be of interest to analysts and
    policy makers.

    CALL FOR RMB FLEXIBILITY
    ------------------------

    ¶3. (U) Tseng observed that despite the introduction of a new
    currency regime in July 2005, the renminbi (RMB) has only
    risen 1.25 percent since the initial 2.1 percent revaluation.
     Though unwilling to provide a target for the RMB's vale
    when asked, Tseng noted several times that Chia is not using
    the full flexibility available toit under the new RMB
    value-setting system.  Ther is a hig cost and a loss of
    policy flexibility ssociated with China's policy of
    partially steriizing excess foreign exchange inflows.  One
    negaive result of this approach is the introducion of
    excess liquidity into the mainland economy, which in turn is
    fueling a resurgence of loans and investment that needs to be
    reined in.

    EMPHASIS ON CHINA AND U.S. IN EFFECTING ORDERLY ADJUSTMENTS
    --------------------------------------------- --------------

    ¶4. (U) Tseng made repeated reference to the U.S. current
    account deficit along with China's accumulation of foreign
    exchange reserves.  She suggested a role for both the U.S.
    and China in managing global financial imbalances.  At this
    point, there is no apparent problem in managing the
    situation, but there is likely medium-term risk considering
    that there is a limit to how much of the U.S. current account
    deficit foreigners are willing finance.  When asked whether
    the U.S. or Asia had a more important role to play in working
    out imbalances, Tseng responded by referring exclusively to
    the U.S., which she said must act "urgently"; a rise in U.S.
    savings will be key.  With regard to China's foreign exchange
    reserves, Tseng would not name a figure that could be deemed
    "adequate," but stated that China has "no need to go further"
    in its accumulation.

    REBALANCING CHINA'S ECONOMY
    ---------------------------

    ¶5. (U) The REO report suggests "a very stark picture"
    emerging from the fact that household consumption in China
    only accounted for approximately 40 percent of GDP last year.
     Although such consumption has grown at an average annual
    rate of 8 percent since the early 1990's, this lags GDP
    expansion.  Savings now make up approximately 30 percent of
    GDP.  One factor in the high savings rate is "precautionary
    savings motives," resulting in part from the decreasing role
    of state-owned enterprises in the provision of pensions,
    health care, and schooling -- and much of this responsibility
    has now been transferred to central and local governments
    that face budget crunches.

    ¶6. (U) Consequently, education spending is now only about
    2.25 percent of GDP, the lowest among Asian economies, while

    HONG KONG 00001839  002 OF 002

    the proportion given to health care is 0.5 percent of GDP.
    Making up for low expenditures in these two areas consumes an
    increasing proportion of household consumption.  Uncertainty
    about such expenses in the future as well as anxieties about
    funding old-age support -- which, in part, derives from the
    effects of the one-child policy -- underpins the need for
    precautionary savings.  Tseng suggested that China reduce the
    uncertainty facing households (and therefore promote their
    propensity to consume) by boosting government spending on
    education, health care and pensions.  The need to save can
    also be reduced through banking reform, which improves access
    to credit, reducing the need to accumulate funds to finance
    major purchases or small family businesses.  Household
    consumption might also be boosted through exchange rate
    flexibility if RMB appreciation raises purchasing power.

    HONG KONG STANDS TO GAIN
    ------------------------

    ¶7. (U) Tseng, joined by IMF Resident Representative Paul
    Gruenwald, said that the demand from the mainland for Hong
    Kong business services remains high.  This is a huge
    advantage for the city in the context of public anxiety
    expressed here about the potential for "marginalization."
    Recent steps to allow mainlanders to invest individually in
    offshore financial instruments are welcome, but the impact on
    Hong Kong is likely to be small in the near term.  The peg of
    the Hong Kong dollar to the U.S. dollar has worked well, but
    its continuation is a local choice.  The IMF forecasts that
    Hong Kong's GDP will likely expand 5-5.5 percent this year,
    down from 7.3 percent in 2006.
    Cunningham

`