International | Jul 06 2006
By Chris Shaw
Following a visit to China and an analysis of recent data, ANZ Bank’s economics team are forecasting figures for the June quarter will show growth in the Chinese economy has continued to accelerate. It expects real GDP growth for the quarter will hit 10.5%, compared to 10.3% in the March quarter.
As this implies the government’s attempts to slow the rate of growth have still not been successful, the bank takes the view further reforms are likely. While it expects such measures to be concentrated on specific sectors and markets such as heavy manufacturing and residential property, the bank sees the need and likelihood of further measure to slow the rate of credit growth, which has implications for the banking sector.
This is important as it is occurring at a time when the Chinese banking system is being further opened to competition both domestically and from global capital markets. The increase in domestic competition will be seen at the end of the year when foreign banks operating in China will be allowed to offer services to all Chinese clients and not just businesses, as has been the case until now. Additionally, the decision of the government to allow qualified Chinese institutions to convert domestic currency deposits into foreign currency for investment globally means new markets and investment products are becoming available to Chinese investors.
ANZ suggests these changes are potentially significant as the potential to invest in new markets means deposits may be shifted from bank balance sheets, these being the deposits that fund the loan books of the domestic banks. This flows through to another problem, in that much of bank lending continues to be to state-owned enterprises, which when compared to the private sector have been poor performers. This brings into question the asset quality of bank balance sheets.
ANZ takes the view while the government wants to increase the level of competition in the banking sector and liberalise operations, its primary goal is to ensure stability, so the pace of ongoing reform of not only the banking sector but of the capital account and the exchange rate should remain fairly slow, as to do otherwise would invite too much uncertainty.
Given the banking sector is therefore unlikely to operate as a relatively free market anytime soon, ANZ cautions against assuming there will be further revaluations in the currency in the short-term either. This is because the likelihood of ongoing regulations in the banking sector will prevent or at least significantly slow the opening up of the current account, which in turn works against introducing a floating exchange rate.
The bank suggests a true floating exchange rate is unlikely to be achieved until capital can move freely both in and out of the country and it is concern about the potential level of outflows and its impact on the banking system that continues to attract the attention of some policymakers.
As a result, ANZ is forecasting no move in the currency beyond a rate of USD/RMB7.0 for several years, particularly as there is likely to be downward pressure on the currency as the capital account is opened up. It also suggests the currency is actually not that far from fair value, which some purchasing-power-parity models estimate at a rate of 7.0-7.5 against the greenback. Combined with the bank’s view the Chinese government doesn’t see the currency as significantly undervalued, it adds up to little incentive for a major revaluation in the Chinese currency anytime soon.
