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					                                                                                 Special
                                                                              Interview


    Profile
 Zhou Xiaochuan is a noted
 Chinese economist who is
 currently the governor of
 the People's Bank of China.
 Ranked #4 in Foreign Policy
 Magazine's 2010 report on
 the Top 100 Global Thinkers,
 Zhou is one of the most
 influential economic
 figures in the world today.




                                                                                     PHOTOS/SHUTTERSTOCK, GETTy IMAGES




Zhou Xiaochuan
“RefoRm is a big systematic tRansfoRmation and
 needs Reasonable aRRangements”
The Governor of The People’s Bank of China talks about Interest Rate
Marketization Reform

                                               EmErging markEts insight   4
                                                                                                                                                      Special
                                                                                                                                                   Interview

  After more than ten years of reform,                  financing has decreased sharply, compared                   As a result, the loan interest rate reform
China's financial sector is ushering in the             with the increased proportion of direct                   can move forward, and deposit interest rate
moment of transition from quantitative to               financing. This proportional change reflects              reform can be pushed forward in various
qualitative change. On April 14, the People's           the reduced room left for interest rate con-              ways, for example, by promoting the devel-
Bank of China announced the expansion of                trol and the strengthened marketization                   opment of alternative debt-attached prod-
the floating range of RMB against the US dol-           forces. The "barbarian growth" of private                 ucts and expanding the range of interest rate
lar from 0.5 percent to 1 percent from the              lending in recent years is also considered to             fluctuation.
16th day of the month. It has been 18 years             be a new round of spontaneous currency
since 1994 when China launched the reform               price protests from the grassroots against                  you once said that the Rmb exchange
of its exchange rate, during which the RMB              financial repression                                      rate was moving toward the equilibrium.
has been appreciating slowly, and is now                    Just like the double-track price system               does this mean it is the right time to adjust
approaching its equilibrium.                            reform started in the 1980's, the double-                 further the exchange rate mechanism?
  With the advent of the equilibrium point,             track interest rate system will eventually go               The situation of China's imbalance
the bi-directional nature of capital flows and          towards the merger after it completes its                 between its international expenditures and
the exchange rate fluctuation are becoming              transitional mission fostering marketization              receipts has eased significantly. The ratio of
increasingly obvious. The unilateral pressure           forces. All these have been included in the               its current account surplus to GDP has come
on the appreciation of RMB and the possible             blueprint designed by decision makers.                    down to 2.8 percent. Supply and demand in
negative effects caused therein will be eased               From the viewpoint of Zhou Xiaochuan,                 the foreign exchange market tends to be
gradually. This will naturally result in the            the Governor of the People's Bank of China,               more balanced, with the RMB exchange rate
reform of the exchange rate mechanism,                  it seems that basic conditions are ripe for               approaching equilibrium. The trend for the
and the dominant control over the interna-              advancing the interest rate marketization                 offshore NDF market also shows that expec-
tional pricing of the RMB will further give way         reform: The fulfillment of a new round of                 tations for the RMB exchange rate have been
to the market.                                          banking reforms which began in 2003 has                   divided. The current exchange rate better
  Compared with the breakthrough in the                 strengthened the hard financial constraints               reflects the supply-and-demand relations.
exchange rate liberalization reform, the fur-           and risk control capability of financial institu-           When the exchange rate comes to equilib-
ther promotion of interest rate marketization           tions; after years of practice, the Shanghai              rium, capital flows will be bi-directional, as
seems ready to proceed. In recent years,                Interbank Offered Rate (SHIBOR) has                       will the exchange rate fluctuations. In this
financial disintermediation has experienced             become an important foundation for pricing                case, the difficulties in pushing forward
rapid development; the bond market is                   financial products; the supporting mecha-                 exchange rate reform will be reduced. As a
booming, and financial products have                    nisms for deposits and insurance, etc. are                result, the conditions to further improve the
become important substitutes for bank                   ready to be introduced. Inflationary pressure             current exchange rate mechanism are more
deposits. The proportion of bank credit loans           at the macroeconomic level is becoming                    mature.
to the total                   volume of social         weaker and weaker.
                                                                                                                     Premier Wen once said he aims to "make
                                                                                                                  the Rmb floating exchange rate regime
                                                                                                                  more bi-directionally flexible." do you think
                                                                                                                  there is a big risk in widening the floating
                                              Financial Reform Process                                            range of the Rmb exchange rate?
                                                                                                                     Regarding the specific reform measures,
                                                                Absorption of Liquidity
                                                                                                                  whether to expand the 0.5 percent daily
                                              Floating Exchange Rate Reform                                       floating range, or make a better use of the
                                                                                                                                                                   PHOTOS/SHUTTERSTOCK, GETTy IMAGES




                                                          Interest Rate Liberalization                            functions of intermediate prices, intraday
                                                                                                                  prices, and closing prices prevailing in the
                                               Financial Institution Marketization
                                                                                                                  foreign exchange market? in the process
                                                            Financial Market Reform
                                                                                                                  of widening the range, will the frequency
                                                 Regulation, Risk Management                                      and means of intervention by the central
                                                               Capital Account Liberalization                     bank be changed?
                                                                                                                    Since the exchange rate reform, the for-
                                             STEP 1                          STEP 2                  STEP 3

                                       Source : IMF, 'China: Financial System Stability Assessment,' 2011
                                                                                                                  eign exchange market has become more
                                                                                                                  and more mature. With the trading volume


                                                                     EmErging markEts insight                 5
                                                                                                                                          Special
                                                                                                                                       Interview

growing, the varieties (of products traded)        ket makers after opening in the morning by       layoffs, or even bankruptcies, so the
increasing, risk-control capacity of the trad-     referring to the inter-bank foreign exchange     employment pressure will increase. If the
ing counterparties gradually increasing, and       market rates and the changes in exchange         exchange rate change is a bit slower, you
the willingness to price being independently       rates of the main international currencies. If   can give enterprises time to make adjust-
enhanced, the RMB exchange rate requires a         market exchange rate flexibility is enhanced,    ments accordingly.
greater fluctuation range in order to adapt to     the central parity price, intraday price, and      During the continuous optimization pro-
the further development of the foreign             closing price of the RMB exchange rate will      cess, some groups in the economy will bene-
exchange market.                                   naturally become more flexible as well. With     fit, while some will be negatively affected, so
  If the floating range is too small, it is easy   the expansion of the RMB exchange rate           there are different views on exchange rate
for the RMB exchange rate float to touch the       floating range, the forces between supply        reform. For example, coastal export regions
boundary. When the exchange rate floating          and demand in the market will play a greater     are more concerned about the rise and fall of
range is expanded, businesses and residents        role, while the central bank should interfere    the export industry, local employment, and
will pay more attention to the role of the         only when the market exchange rate fluctu-       inward foreign direct investments, while
price factor as well as the market allocation      ations exceed the limit. So the frequency of     inland areas may have other concerns. From
of resources. We will take measures to man-        intervention will be reduced, but also           an economic point of view, it is best for the
age the exchange rate risk actively, and rein-     become more flexible.                            exchange rate to remain close to the equilib-
force the micro-foundations for setting the                                                         rium point. If the exchange rate deviates
exchange rate. The so-called "expanding the           the exchange rate is an important price       from the equilibrium, it will lead to disloca-
floating range" should expand the 0.5 per-         of funds. the exchange rate reform relates       tions in the allocation of resources, resulting
cent floating range of the trading price of        to the issue of optimizing the allocation of     in losses to the national economy and also
RMB against the US dollar in the interbank         foreign and domestic resources in china's        creating difficulties for China's monetary pol-
foreign exchange market.                           economic development. there is no con-           icies. But these losses and difficulties are not
  Historically, the RMB exchange rate float-       sensus on the exchange rate reform as            so intuitive, and usually are not understand-
ing range has been gradually expanded. The         some are in favor of it and some are             able by common people.
RMB exchange rate floating range was 0.3           against it. Why does it attract so much con-       In particular, if the US requires the appre-
percent in 1994, then 0.5 percent in 2007.         troversy?                                        ciation of RMB, the problem will become
Up to now, as the floating range has passed          There are two main reasons to explain          more complex. To some people, what the US
the five-year adaptation period, and with the      why the exchange rate issue is so contro-        requires is certainly not a good thing.
construction and development of the foreign        versial: First, the impact on employment. If
exchange market since the exchange rate            the exchange rate changes too fast, enter-         When debating exchange rate reform in
reform, the capabilities of the market mem-        prises are unable to adapt. This may lead to     2003 and 2004, people had different ideas;
bers to perform independent pricing and risk                                                        some adv oca t ed the "pr ogr essiv e"
management have continued to improve.                                                               approach because they believed that the
The ability of enterprises to bear the floating                                                     risk would be too large in the case of a
exchange rate has also been enhanced.                                                               one-time adjustment, while some advocat-
  There is a need to expand the RMB                                                                 ed a "big jump" approach. What do you
exchange rate floating range appropriately                                                          think about this issue? is it time now to
to accommodate the further development of                                                           make a one-time "big jump" adjustment?
the foreign exchange market and to reflect                                                            In 2005, the exchange rate reform was
the more dominant role of the relationship                                                          conducted in a "Big-Jump-and-Progressive"
between supply and demand. Of course, the                                                           combination where the first step was to
central bank also has various means to                                                              jump and the second step was to make pro-
administer and regulate the exchange rate                                                           gressive adjustments.
when necessary in order to maintain the                                                               However, people had different ideas about
normal floating range of the RMB exchange                                                           the jump-like adjustment with some people
rate, so the risks can be effectively con-                                                          advocating 5 percent, some suggesting 3
trolled.                                                                                            percent, and some believing it should not go
  The central parity price of the RMB                                                               higher than 1 percent. Finally, we decided to
exchange rate is currently formed based on                                                          jump by 2 percent. That exchange rate
the prices quoted by foreign exchange mar-                                                          reform did not generate the significant

                                                          EmErging markEts insight      6
                                                                                                                                     Special
                                                                                                                                  Interview


                                                                                                 ion, should the new round of interest rate
                                                                                                 marketization reform be pushed forward
                                                                                                 as soon as possible?
                                                                                                   The interest rate marketization is a pro-
                                                                                                 cess. Before 2003, the floating range bank
                                                                                                 loan prices were limited to less than 30 per-
                                                                                                 cent, but in 2004, the upper limit for loan
                                                                                                 interest rates was extended to 1.7 times the
                                                                                                 benchmark interest rate. In October 2004,
                                                                                                 the cap for loan interest rates was cancelled;
                                                                                                 and the lower limit was set at 0.9 times the
                                                                                                 benchmark interest rate. At the same time,
                                                                                                 China began to allow bank deposit rates to
impact that people had imagined, but it did     to long term, making future investments          float down without any lower limits. The
reduce the international pressure, taking a     focus on domestic demand (especially the         inter-bank bond market interest rates were
step forward towards the improvement of         service sector). An appropriate reduction in     also liberalized. We also advocated liberaliz-
the exchange rate mechanism.                    investment in production capacity for            ing the corporate bonds interest rate.
  Now that we have identified the strategy      exports will help promote domestic demand-       Although we haven't liberalized the banks'
of progressive reform, and have gone with it    oriented industrial restructuring in the medi-   lower limit for lending rates, some quality
for so many years, we are approaching the       um term.                                         enterprises were freed to issue corporate
target, so we should continue forward. It is                                                     bonds at a price without being limited by the
not necessary to alternate progressive            the internationalization of the Rmb is         benchmark lending rate.
changes with "jump-like" changes. As China      continuing to accelerate. some advocate            At present, interest rate marketization
is a major power, I believe that we can         reverse-forcing domestic financial policy        reform can be further advanced, as it is
achieve the target by keeping on the "pro-      reform through the internationalization of       being designed and tested. We can take a
gressive" approach.                             the Rmb. do you think this reverse-force         step forward in the reform of the lending
                                                mechanism actually exists, or not?               interest rate, and the deposit interest rate
  in your opinion, how can the domestic           The "reverse-force" idea always comes          reform can be pushed forward by promoting
exporters make their adjustments to             from comments "after the fact." In promot-       the development of alternative liability prod-
address the appreciation of the Rmb             ing the process of internationalizing the RMB,   ucts and expanding the range of interest rate
exchange rate, and how much impact will         no one can expect to perform "reverse-           fluctuations, among other measures.
be imposed on the export industry?              force" reform, and this approach is not very
  The exchange rate reform relates to the       realistic.                                          you have been stressing that the hard
time for the improvement of export enter-         However, we do not rule out the fact that      constraints over the bank-related financial
prises, including how to make progressive       the "reverse-force" idea is like the "forcing    institutions are the premises for interest
adjustments on products and technologies,       -rebounding" theory. If some areas need to       rate marketization reform. can you tell us
and how to win back some of the pricing         be reformed, but it is impossible to do, we      something about the present status of hard
power. In fact, the pricing power of Chinese    can first reform other aspects, thus creating    constraints over china's financial institu-
enterprises has gradually been expanding.       pressure on the slow aspects, and then push      tions and their progress? Why do we have
Our survey finds that the adjustment capaci-    forward reform of those aspects which are        to control the upper limit for deposit inter-
ty of Chinese enterprises is also strong.       difficult to advance. This possibility is too    est rates and the lower limit for lending
Many export enterprises have survived dur-      dramatic and story-like, so this will not hap-   interest rates during the 2014 reform?
ing the reform process.                         pen when conducting the conventional               This should be seen from two perspec-
  The numbers of export enterprises which       design.                                          tives. Before the global financial crisis, we
laid off workers on a large scale and went                                                       were studying in detail interest rate marketi-
bankrupt due to the exchange rate reform          it has been many years since we began          zation reform. We felt that the progress of
were few. This is also a benefit of the pro-    to discuss and implement the chinese             the reform varied among banks. I should say
gressive reform. The exchange rate adjust-      interest rate marketization reform. Where        that banks — after the shareholding reform
ment will give a clear signal over the medium   do you think the reform is at? in your opin-     — had basically realized the hard constraints.


                                                        EmErging markEts insight     7
                                                                                                                                          Special
                                                                                                                                       Interview


                                                                                                      debt or related businesses (such as the
                                                                                                      absorption of deposits). In this regard, this
                                                                                                      may not be well received by banks partially
                                                                                                      because the long-term interest rate control
                                                                                                      allows commercial banks to form a strong
                                                                                                      dependence, so when customers question
                                                                                                      them, they can also pass the buck to the
                                                                                                      central bank by complaining that they do not
                                                                                                      determine the price. The other side of coin is
                                                                                                      that once the interest rate controls are can-
                                                                                                      celled, commercial banks will face greater
                                                                                                      market pressures, including competition for
                                                                                                      loans and also competition for deposits.
                                                                                                        They have to give their own explanations
                                                                                                      to customers. For example, after the
                                                                                                      Wenchuan Earthquake, the People's Bank of
                                                                                                      China expanded the lower limit for commer-
                                                                                                      cial individual housing loan interest rates to
It was possible for them to worry about the       rural credit cooperatives had not yet been          0.7 times the benchmark interest rate, which
increase in costs for deposits, with the result   established at that time.                           enhanced the independent pricing power of
that they were not willing to raise interest        At present, almost one-third of rural credit      financial institutions. However, some finan-
rates on deposits. Some banks had not yet         cooperatives' capital is compliant with the         cial companies do not want to exercise their
finished their shareholding reform, so they       regulations, one-third needs one or two             independent pricing right for their mortgage
were not bound by the hard constraints;           years to reach the standard, and another            loans for housing.
thus, they could compete with each other          one-third hasn't reached the 4 percent capi-          Although the reform cost has been gradu-
regardless of the actual costs and benefits.      tal adequacy ratio. About less than half of         ally absorbed and hard constraints have
In addition, the financial constraints on com-    their capital is negative. If there are no effec-   been established gradually, there are some
mercial banks and policy-driven banks are         tive capital constraints, competition will often    issues at the grassroots level such as the
completely different, so there is no way to       be cautious. What will happen to the worst          uneven progress of the reform of rural credit
create fair competition between them.             one-third of rural credit cooperatives if we        cooperatives. With the outburst of the finan-
Before the full realization of the hard con-      accelerate the interest rate marketization          cial crisis in 2008, a new situation has been
straints over financial institutions, the trend   reform? Do we give or not give them inde-           created.
was for the poorer quality banks to dare to       pendent pricing power? In a case of unfair
raise their deposit interest rates, for some      competition, the ethical risk will emerge, so         What is the new situation?
securities companies that were in trouble         we should give them time to meet the stan-            After the crisis, the developed countries
were having to issue OTC bonds at a higher        dard.                                               began to implement quantitative easing of
rate in order to save themselves. They just                                                           monetary policy with very low interest rates,
took a risk to see if they could survive the        marketizing the interest rates means              leading to the flow of "hot money" to emerg-
crisis.                                           that commercial banks will be entitled to           ing markets with relatively high interest
  In fact, the pilot reform work was first        the independent pricing power, but what             rates, including China.
conducted at the beginning of this century,       about the current independent pricing                 Our basic view is that we need not be
allowing the rural credit cooperatives to raise   capabilities of the commercial banks?               afraid of "hot money," because we can build
their deposit rates. However, they quickly          One cannot say that all issues can be             a "reservoir," such that the central bank can
raised their deposit interest rates to the cap,   solved as long as control over interest rates       hedge the hot money when it comes, not
and then passed the risks on to lending           is released. Commercial banks have to price         allowing them to expand the money supply
interest rates, thus raising the overall finan-   independently after the interest rate mar-          so as to reduce the negative influence on the
cial costs of enterprises. The competition        ketization is completed, not only including         national economy. Later on, the "hot money"
over the deposits reflected the fact that the     the independent pricing of lending interest         can freely flow out, even after making some
capital and cost constraint mechanism of          rates but also the independent pricing of           money because they do not earn very much.

                                                          EmErging markEts insight       8
                                                                                                                                         Special
                                                                                                                                      Interview


  However, there are many departments             factory or hampered, potentially even com-       system and selective exit mechanism, based
and experts worried about the inflow of "hot      ing to an untimely end in the process.           on selecting the superior and eliminating the
money." In a situation where people are not                                                        inferior among financial institutions, are both
satisfied with domestic inflation, "hot              We note that, in your recent article pub-     under construction, and will create a more
money" always becomes a target for criti-         lished in China Finance, you pointed out         favorable environment for financial institu-
cism. Therefore, we must take control of the      that the Pbc would go on actively promot-        tions to conduct scientific and reasonable
"hot money."                                      ing interest rate marketization, based on        pricing for both products and services under
  However, the difference between foreign         the direction of related meetings of the         market competition. Therefore it can be said
interest rates and domestic interest rates is     central government, because the condi-           that the conditions for further promoting
clear, so what can we do to address the prof-     tions for it are ready. What's your basis for    interest rate marketization are basically
it-driven motive behind "hot money"? Under        this judgment? is it feasible to relax inter-    ready.
such pressure, we need not hurry to                     est rate regulations at this time?           Of course, it's impossible to make all
reform deposit interest rates.                                   Interest rate marketization       reform conditions fully ready. People recog-
  Therefore, the negative                                         was written in China's "12th     nize the merits and demerits of reform in dif-
real interest rates are                                              Five-Year" Plan, and we       ferent ways through all periods. In addition,
formed by the joint                                                     also made a partial        reform brings different benefits and costs to
effect of several fac-                 We need                           report on the "12th       different bank groups and customer groups,
tors not intentionally           a competitive market                     Five-Year" Plan for      so banks and customers may have different
selected by us.                  structure, otherwise                     the financial sector.    opinions or attitudes about reform.

                                 "big banks may bully                     We decided to pro-         Compared with the past, if the marketiza-
   the international                                                     mote the marketiza-       tion reform of interest rates is implemented
                                      customers."
financial crisis is an                                                  tion reform of interest    now, cut-throat competition is less likely to
influencing factor                                                   rates conditionally, but      occur, but "hot money" may become a rela-
affecting the interest rate                                       we have to overcome some         tively more common occurrence. It's critical
marketization of our country.                                 difficulties during this effort.     to measure the merits and demerits of
are there any other significant factors                 Since 1996, with the relaxation of         reform correctly as no single reform mea-
besides this?                                     restrictions on interbank offered rates, the     sure can be fully beneficial and without any
  There are some other key factors. For           marketization reform of interest rates has       cost to anyone.
example, we need a competitive market             been implemented stably, the market pricing
structure, otherwise "big banks may bully         right of financial institutions has been           in your opinion, what's the practical
customers" even if banks can conduct inde-        expanded continuously, and the market            route for implementing the marketization
pendent pricing in the event that there are       mechanism has played a more and more             reform of interest rates?
only a handful of banks. Once a competitive       obvious role in the pricing of financial prod-     An alternative would be to allow qualified
market structure forms, it can encourage          ucts, including deposits, loans and bonds. In    financial institutions meeting hard restriction
banks to compete with each other by means         recent years, the financial reorganization       conditions and macro prudent policy frame-
of the market, observing and respecting cus-      and joint stock system reform of commercial      work requirements to expand their indepen-
tomer's choices, and further, by improving        banks have made periodical achievements,         dent pricing right; establish and perfect the
their customer service.                           the hard restriction on financial institutions   self-disciplined management of competition
  In addition, macroeconomic conditions           has been further enhanced, and their inter-      in transition, and let the qualified institutions
such as inflation should be considered. When      est rate pricing and risk control capabilities   above begin conducting independent pricing
reform is driven during periods of low infla-     have been greatly improved.                      for interest rates. Meanwhile, we should con-
tion, commercial banks experience bi-direc-         Meanwhile, the PBC has gradually               tinue to cultivate the market driven interest
tional stresses while doing independent pric-     improved its capability of regulating market     rate system, perfect the interest rate mech-
ing; as a result, prices may fluctuate. In con-   interest rates by means of open market and       anism of the PBC, and guide the improve-
trast, during periods of high inflation, people   other operations, and also cultivated the        ment of the interest rate pricing capability of
expect price increases, thus a unilateral         market driven interest rate in the money         financial institutions. The PBC has made
trend of prices is likely to appear even          market (Shanghai Interbank Offered Rate,         active and beneficial explorations of self-dis-
though independent pricing has been imple-        SHIBOR) which is used for pricing financial      ciplined pricing during the development of
mented. Further, the reform may be unsatis-       products. In addition, the deposit insurance     SHIBOR in recent years, and should go on


                                                         EmErging markEts insight        9
                                                                                                                                            Special
                                                                                                                                         Interview


perfecting and enhancing such pricing in the         infrastructure from time to time, no matter       ments and regions will complain, so hedging
future. In this way, interest rate marketiza-        whether construction costs are high or low,       may well offend certain groups.
tion should be realized after a period of tran-      given the drive to makepolitical performanc-        If some tools of open market operations
sition.                                              es. In addition, how do increases in interest     are used for hedging, their effects won't be
                                                     rates influence the savings ratio and con-        visible, but opponents will also make an
  the reason for the slow pace of interest           sumption? This issue may be significant           objection affecting policy-making once they
rate and exchange rate reforms is that the           when selecting policy tools.                      realize the intent. In addition, open market
marketization of chinese macro control                 In summary, China and developed coun-           operations may obviously influence short-
has seemed insufficient over the past ten            tries have some different worries, so Chinese     term market interest rates. In summary, no
years, with monetary policies attaching              policy selection should be based on the anal-     methods are perfect.
more importance to quantitative tools rath-          ysis according to our national conditions.
er than pricing tools. What do you think of                                                             can the "Pool" be richer in content?
this problem?                                          can existing hedging measures counter-          What are its effects?
  First, Chinese policy-makers prefer quanti-        act inflationary stress? What are their             A good many methods are effective for
tative tools following the thinking behind the       effects? What are the related difficulties?       making appropriate money supply. Every
previous centralized planned economy in                Amortization of reform costs is always a        stage has its own characteristics. In our
which both supply and demand were                    medium and long-term issue not reflected in       opinion, hedging measures are diversified,
planned, broken down, and conveyed to                the short term. If the change in foreign          but they are seldom noted. Once clarified,
lower levels according to quantity, regardless       exchange reserves is not overly large, it         they are usually controversial. The concept
of either the law of value or of price tools.        won't obviously influence inflation in the        of a "pool" is a vivid analogy put forward for
Hence, such preferences have a long-stand-           short and medium term.                            absorbing excessive liquidity, which is mainly
ing historical cause.                                  Overall, inflation is involved whenever the     pertinent to the great increase of money
  Second, in order to respond to the current         money supply is excessive; thus, the excess       supply experienced with an overly-quick
financial crisis, some western countries, e.g.       should be hedged. If the hedge is sufficient,     increase in foreign exchange reserves. It can
America and the Eurozone in sequence,                obviously inflation won't result; moreover,       be said that this method has a very good
adopted quantitatively relaxed monetary              the excess can be placed in a "pool" and then     effect. Meanwhile, this concept may be
policies. As a result, the globe has surplus         released after inflationary pressure cools.       explored and realized in different ways.
liquidity and strong capital flows, with quite a       It is criticism of hedging measures that          The reform of our country is a systematic
lot of capital flooding into emerging market         brings inflationary stress. If the criticism is   transfer to a different track and places higher
economies, while some countries were                 loud, the hedging may be insufficient, and        requirements on the overall supporting rela-
severely shocked and objected to such poli-          inflation may prove inevitable. With the          tionship. Currently we need to consider the
cies. In this case, a natural choice is to           increase in reserves against deposits, unfa-      overall situation when implementing interest
respond to quantitative relaxation by quanti-        vorable voices will be louder, some depart-       rate and exchange rate reforms. Of course,
tatively tight policy.                                                                                 this doesn't mean that such reforms can't be
  Third, an economic law of developed                                                                  implemented until all conditions are fully
countries is that long-term interest rates rise                                                        mature.
with increases in inflation. As a result, the
interest in investing falls. In China, it's unique                                                       since the 14th national congress of the
that the savings rate is overly high; for                                                              communist Party of china, more impor-
example, household consumption accounted                                                               tance has been attached to the question of
for only 33.8 percent in GDP in 2010, and                                                              how systematic reform will or should be.
such a level of consumption is rather low.                                                             how should we understand how systemat-
How much will interest rate increases affect                                                               ic reform has been?
investment? Governments at all levels                                                                               The reform of our country is a
make much administration-driv-                                                                                   systematic transfer to a different
en investment in infrastructure.                                                                                 track and places higher require-
Although high interest rates can                                                                                 ments on the overall supporting
increase long-term investment                                                                                    relationship. The central govern-
costs, they may still invest in                                                                                  ment and the s t at e c ouncil


                                                           EmErging markEts insight       10
                                                                                                                                              Special
                                                                                                                                           Interview


emphasize such relations all the time. Price        in resource allocation. here the issue is         ple expect that relaxed macro policies can
reform has high support requirements, so            how reform brings about benefits. at pres-        alleviate the problem of "difficult loan acqui-
we need to create related conditions and            ent, people pin their hopes on the market         sitions and high loan costs," but only macro
take actions for the formation of a support-        reform of interest rates to alleviate the         policies inhibiting inflation are really helpful.
ive relationship; further, we must guarantee        problem of "difficult loan acquisitions and
the realization of our objectives. Looking          high loan costs." What are your thoughts           this implies that marketization reform
back at the reform process, it can be seen          on this?                                         should b e pr omo t e d wi t h an e y e t o
that price reform has been combined with                It can be said that our reforms, in general, resource allocation optimization rather
autonomous management and independent               pursue optimal resource allocation                        than with reference to any short-
pricing by enterprises. Meanwhile, price            and high allocation efficiency.                                term problems. therefore
reform is interlinked with indirect tax reform,     Some people think reform                                          we should clarify our
clarification of relations between domestic         is intended to solve cer-                                           thought, create related
prices and international market prices, etc.        tain problems rather
                                                                                      Of course, this doesn't             conditions, and
  Therefore, we can see that the premise of         than improve the                                                       remain determined.
                                                                                     mean that such reforms
keeping overall price levels relatively stable.     overall efficiency of                                                  do you agree with
Further, the issue of marketization of factors      resource allocation.           can't be implemented until              this?
of production are emphasized in "relaxing           For example, some                       all conditions are                     Quite so. At first,
the restrictions on the prices of competitive       people think the mar-                      fully mature.                   we shouldn't only see
goods and services, canceling the dual track        ket reform of interest                                                   some superficial prob-
system for factor prices as soon as possible,       rates is a recipe for han-                                             lems when analyzing the
and quickening the marketization process of         dling such problems as the                                         mer it s and demer it s o f
factor prices" in the document of the 14th          "difficult loan acquisitions and high                        reform. The main merit of marketi-
National Congress of the Communist Party of         loan costs," as well as high bank profits.        zation reform is higher efficiency and optimi-
China.                                                In the early stages of reform, people           zation of resource allocation, as this is the
  In view of the main supporting relation-          always attributed the distortion of goods         foundation of the benefits to the public rath-
ship, value-added tax reform and exchange           prices to "long-distance transport, specula-      er than a solution to a variety of different
rate reform were emphasized in 1993 and             tion, and profiteering" during turnover. Later    problems.
1994, supporting the market reform of good          it was found that this attribution was wrong,       In the past, many problems concerning
prices and factor prices to a very large            although the circulation process is problem-      low efficiency existed in our economy and
extent.                                             atic, circulation, an intermediate link, mainly   society, and all of them were directly or indi-
  For the correction of price distortions,          plays a role in conveyance. In fact, it only      rectly related to the distortion of the price
attention should be paid to the following two       delivers the problem of production to the         system, but related reforms might impinge
aspects: I. Goods prices contain turnover           retail market. The financial sector, similar to   on the interests of some groups, and some
tax, and the product tax system was prob-           the circulation discussed above, mainly play-     people worried that price reform was likely to
lematic because of unfair tax rates and dupli-      sthe role ofan intermediary and delivers its      aggravate inflation and couldn't make up
cate taxation at that time, causing price dis-      capital surplus to the customers demanding        their minds, and some even attempted to
tortions; II. Domestic price levels were not        money; thus, it usually also conveys or           evade such difficult reforms altogether. Clear
consistent with international price levels,         transfers price.                                  recognition of all these problems can help us
dual or even multiple exchange rates exist-           We should note that, "difficult loan acquisi-   become determined to promote related
ed, both export rebates and import taxation         tions and high loan costs," at a particular       reforms.
were very difficult, and enterprises could not      stage, are related to the macro situation of        Reform is a big systematic transformation
participate in international market competi-        high inflation rates and heavy stress on total    and needs reasonable arrangements.
tion at the same initial price points, triggering   demand control, and may not be always             Meanwhile, Pareto improvement, i.e. contin-
a lot of trade friction. Smuggling and illicit      solved by the micro pricing mechanism. If         uous resource allocation optimization, should
exports further impaired overall interests.         necessary, macro conditions aren't ready,         be embodied in a progressive reform pro-
                                                    and relaxed restrictions on interest rates        cess. Such optimization will bring about ben-
  l ooking back at pr e vious mark e t              may actually increase loan costs. The real        efits and advantages. Just like a pie grows-
reforms, an important guideline is to give          merit of interest rate marketization lies in      bigger and bigger in the oven, it must have
play to the fundamental role of the market          resource allocation optimization. Some peo-       its own inherent theoretical basis.


                                                           EmErging markEts insight         11

				
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