People’s Republic of China was formally established in October 1949 under one party rule. This sleeping giant of a nation is undegoing a fundamental change in its dynasty moving towards a modern market socialist economy from its very long history of an agricultural society. Within the world of money, a just as dramatic development is taking place within China’s currency, the yuan/renminbi. In due time, the yuan will be one of the world’s premiere sound currencies as China advances forward. And these milestones are evident in many areas including China’s space program with a national goal of a moon mission by 2020. Shanghai city itself is moving towards a modern visionary city, home to the world’s fastest train and to be Asia’s future global financial capital.
In the 21st century ‘China’s century’, China will achieve ‘Superpower’ status as the economy evolves to the largest in the world coupled with a military establishment that will command all the necessary weapon systems to be a significant military power. China’s current populalation of 1.3 billion is going to help propel the next large phase of global economic growth as China becomes a major regional bloc in relation to North America, Japan and Europe. Currently, the national currency renminbi/yuan is relatively stable although its peg to the US-dollar (‘USD’) has resulted in its depreciation to several of its neighboring currencies in addition to the Euroland euro ‘EUR’ over the last two years. China is currently experiencing huge capital inflows resulting in its massive foreign exchange holdings.
Since 1998, the government has successfully deflected the deflationary threat from the fallout of the 1997-98 regional currency crisis with increased government forced stimulus measures resulting in manageable deficit spending programs. Monies were allocated for construction and infrastructure, as well as tax reforms directed towards thrifty Chinese consumers who save in excess of 40 percent of their income, one of the world’s highest savings rate. Chinese leaders are opening up the economy to free market reforms, to be tied with rest of world, information and knowledge-based. World Trade Organization (WTO) membership in December 2001 is allowing China to open up domestically with improvements in the financial & banking sectors, legal system and distribution channels. China has benefitted from steady increases in foreign direct investment (FDI) for most of the 1990’s and early 2000’s. November 99: implementation of savings deposit tax encouraging shift from savings to consumption. Spring 2000: soaring merchandise exports. September 20, 2000: the United States Senate approved permanent normal trade relations (PNTR) with China.
A heavily protected domestic market coupled with an undervalued currency has helped China maintain the country as one of the few currently growing during this global recovery & recession. China is a dichotomy of two economies, one is a huge rural economy consisting of 800 million peasants who are mainly poor, the other is a wealthier urban group consisting of 500 million people and growing. The upper middle class/rich now account for 1 to 2 percent of the population (30 million people) who enjoy Western bourgeois goods & lifestyle. Today, Shanghai is dominated by massive skyscrapers, smog, advertising in English for Western products is evident everywhere, a city that will be the financial & banking centre for all of Asia. More recently, Beijing has been rewarded the year 2008 Olympic summer games and the city of Shanghai with the 2010 World Expo. Temendous change is taking place within China with the arrival of the Internet, satellite television, more freedoms, pizza & hamburgers - the Western influence. Immediate misallocations of capital include too much infrastructure in areas such as new hi-speed railways, massive construction spree particularly in Shanghai where the city is sinking under the weight of all the new construction and its skyscrapers.
POLITICS: political control is tight as China is a communist country with no free press in order to maintain the stability. Chinese Communist Party (CCP) with its approximate 70 million members has ruled China since1949 with Jintao Hu as the current President since March 15, 2003. The Nationalist regime ruled China from 1911 to 1949, and previous to this was the Imperial era. The CCP has fundamentally evolved and changed to a more central progressive insititution as it now allows capitalists to join the party. There is virtually no formal political opposition to the ruling regime. Presently, there are power divisions between regional leaders, regional economic inequalities in various parts of the country and the shifting of moral values including the Falun Gong spiritual movement. Separatists are threatening in Xinjiang and Tibet. During 1999, Chinese leadership in Beijing pursued a social policy of silencing the rights of dissidents and other groups in order to maintain internal stability. They are seeking to find a balance between economic reforms and economic policy based on social stability rather than market fundamentals in order to avoid widespread unrest that could undermine China’s leadership. With respect to the Taiwan issue, China over time will resolve this long standing dispute as the two economies realize closer economic ties and political differences that will dissipate. In fact, large numbers of Taiwanese are in Beijing and Shanghai setting up businesses taking advantage of China’s wage structure. For further information on this debate, please click TAIWAN in this BI.C currency index.
China is advancing into hi-tech military weaponary with nuclear strike capability, including the purchase of much Russian military hardware in submarines, missiles, etc. Defense budget is at 1.5 percent of GDP although the military is on path to decline to 2.3 million persons as it modernizes. China’s new venture into space exploration and has ambitious plans for military & naval expansion (Navy with 1100 ships) in order to protect shipping lanes for vital oil imports. The government have several challenges as they implement a massive realignment and restructuring of China’s inefficient ‘State Owned Enterprises’ (SOEs) in order to bring efficiency, modernization and production of quality products to market in order to compete within the WTO. Politically, SOEs is an area of great caution to the Chinese leadership. SOEs are currently overstaffed by 20 percent and consist mostly of China’s heavy industry - employs approximately 30 percent of urban work force. The restructuring of SOEs to more modern management systems coupled with new large FDI investments are throwing 4 million people per year out of work since the majority of SOE’s are highly unprofitable.
ECONOMY: relaxing, reforms and moving towards a modern social market capitalistic economy for the world’s current sixth largest economy - China as measured by market prices or the second largest as measured by purchasing power parity behind the United States. By not devaluing the renminbi during the 1997-98 Asian financial crisis, China has experienced a mild deflation up until the last year where inflation is now a major concern with quickly rising prices within a credit bubble with expensive real estate in specific regions and general stock market valuations coupled with money growth reaching 20 percent. Year 2003 recorded China’s best annual GDP growth rate in 7 years. China’s external trade is now becoming balanced except for the United States trade account. The overall economy is opening up to foreign investment with several large multi-national corporations investing and joint venturing large amounts of monies into China. Motorola of the United States announced an investment of $3 billion USD in 2001 to take place over five years, they currently have 13,000 employees (year 2001) within China. Globalization within China is taking affect in a large way, NewsCorp and AOL Time Warner are now allowed to enter China. The government is very proactive in the economy by continuing with a domestic stimulus package coupled with regional development programs. Western China is struggling economically while the eastern part of the nation is much wealthier including the province of Guangdong where the majority of Chinese exports are derived. Several large Chinese corporations are now going public seeking international stock listings. China with unlimited cheap labour pool is destined to be the world’s largest manufacturing centre for the next 25 years.
WTO membership is very positive for wealth accumulation over the long term for China. Membership will see challenging short to medium difficulties as millions of Chinese transfer to more productive parts of the economy away from state-owned industries and inefficient agricultural sectors of the economy. This misalignment will create efficienies and modernization of Chinese industry although painful with millions more temporarily unemployed as this shift continues to take hold over the next several years. Higher growth rates will absorb these unemployed as the market economy will help maintain this economic & social stability. China is becoming quite productive as output shifts are moving into computer hardware manufacturing. Unemployment is estimated at 10 percent with underemployment guessed at 30 percent in the rural areas. WTO will further encourage reforms, new economic opportunities as China opens up to the outside world which will help foster political liberalization within China.
It should be noted that labour costs in China are 3 percent of that in Japan and only 6 percent to those in South Korea & Taiwan. China has now attained the title of the world’s global manufacturing centre primarily due to it having the world’s largest pool of low-cost labour coupled with it being a major global outsourcing centre for major international corporations. Large Chinese manufacturing centres include the Pearl River in Guangdong Region where upwards of 30 million plus work in southern China. Foreign Direct Investment (FDI) into China is substantial with FDI for year 2001 at $46 billion USD since China has a buoyant manufacturing sector. Beijing is careful to monitor the economy as any significant slowdown may impact social stability and have devestating consequences to the ruling CCP. The key to the Chinese economy is to stimulate domestic demand and lower the national savings rate in order to increase consumption in order to offset slower exports from an expected yuan/renminbi revaluation in the near term. FDI monies are being directed to telecommunications and high-tech industries within China.
The introduction of the stock market is a move toward economic global integration of a free market economy as reform & capital are required to finance this huge economy. The Chinese stock market is now considered to be expensive. China’s social security system, capital markets and the insurance industry will see significant development over the next few years. The country is rich in coal, hydroelectric power, minerals & metals as well as staking and taking claim to oil interests abroad to secure future energy supplies. The Chinese economy is diversified from defense & aerospace, high-tech, agricultural, natural resources and manufacturing.
China is an emerging market currency, still small in global output share at 4 percent of world GDP with its trade position at only 5 percent. Market GDP by year 2020 to quadruple to $4.5 trillion USD for China as the Chinese people will desire to have cars with only 1 percent of Chinese people presently owning cars, in addition to other consumer goods such as electronics, music, clothes that much of the West enjoys. China to be a major driving force of the world economy going forward over the long term while it shifts more towards a hi-tech manufacturing centre including electronics, autos, computers, etc. to service this large domestic demand. China is driving the global commodity boom. However, over the short term immediate economic risks are prevalent such as a credit bubble due to an overheating economy with inflation risks heating up. In China’s history, there are times of hyperinflations.
Economic Statistics
GDP market is measured at $1.3 trillion USD with corresponding GDP/Capita at $1,000 USD. Some have suggested that the black market economy is also another $1.3 trillion USD in size. GDP as measured by PPP is at $6 trillion USD (2002) with equivalent GDP/Capita at $4,600 USD. Real GDP growth is booming with year 2000 at 8.0 percent, 2001 at 7.5 percent, 2003 at 9.1 percent with QTR4 2003 at 9.9 percent and year 2004 estimated at 6 to 7.5 percent. CPI figures include year 1998 with a mild deflation at 0.8 percent, 1999 at -1.4 percent, year 2000 at positive 0.4 percent , year 2002 deflation of of 0.7 percent, year 2003 with higher CPI inflation at 2 percent, December 2003 at 3.2 percent and 2004 is estimated between 3 and 5 percent. Current account is forecasted to stay in surplus with 2002 recording a surplus of 2.8 percent of GDP and 2003 at 2 percent. China is the world’s fourth largest exporter. Fiscal deficit has been running between 3 to 4 percent of GDP for the last 5 years. National debt levels outside of domestic banking system difficulties have moved higher to approximately 100 percent of GDP. October 2002 external debt is at $170 billion USD. FDI (2002) at $53 billion USD. Major export partners include United States, Hong Kong, Japan while major import partners include Japan and Taiwan.
POSITIVE: IMF member, China - EU trade deal, US trade surplus in favour of China at over $110 billion USD (2003) and growing with year 2001 at $28.2 billion USD and 2002 at $43.3 billion USD, huge foreign exchange reserve position, huge pool of domestic savings, large efficient low-cost labour supply, China’s banking system is advancing with the introduction of mortgage financing & home ownership - this financing technique popular in the West will be a key tool to China’s modernization, reform in constitutional laws for private business. Tremendous growth rates with Internet & mobile phones. Shift within the VAT from production to consumption which is positive for tax collection similar to many industrialized nations, 86 percent literacy rate, average life expectancy is 72 years. CONCERN: lower grain harvest - food shortages in areas, water shortages, Taiwan tensions, China’s rural banking system is fragile, lax rules for intellectual property rights, WTO acceptance - China’s millions of peasants and workers are not ready for foreign competition particularly in agriculture, projected population of 1.5 billion by year 2040, currently only 1.5 million college students.
BANKING SYSTEM: weakest link in China’s economic advancement with non-performing loans ‘NPL’ estimated as high as 400 billion USD equivalent in the Chinese banking system. Other estimates have this figure closer to $850 billion USD representing 45 percent of Chinese bank loans. The banking system needs to be strengthened although it is slowly opening up to foreigners. China recently rejected Basel II rules although Chinese banks are obliged to maintain an 8 percent capital adequacy ratio requirement. State-owned industries command about 90 percent (2001) of the financial services of the ‘Big Four’ government owned banks, thus creating a financial difficulty as these banks are technically bankrupt. The government plans to sell stakes in these big banks in order to increase capital, the goal is to decrease the NPL of the big four to 15 percent by year 2005. China’s foreign exchange reserves are the second largest in the world behind Japan at a very healthy $403 billion USD (year-end 2003) which includes the cost of $45 billion USD to inject capital into 2 of the large 4 Chinese banks for recapitalization, Bank of China and the China Construction Bank. Some think another $60 billion USD from reserves will be required to shore up the big four although they are planning initial public offerings (IPO’s). It is also interesting to note that only a small percentage of China’s reserves are held in gold with the majority held in USD reserves although the gold component and foreign currency position may begin to increase. The central bank, People’s Bank of China (PBOC) may hedge this currency risk by shifting reserves into the EUR and gold away from the USD.
Is a banking crisis loom ahead particularly if interest rates rise? Chinese interest rates ‘Deposit Reserve Rate’ was raised to 7 percent from 6 percent in August 2003 in an attempt to prevent the economy from overheating. Interest rates may begin to rise in second half of 2004 as domestic inflation approaches 5 percent. During year 2000, mainland savings reached over $800 billion USD and growing at over 10 percent annually representing a massive pool of capital for Chinese banks although a mismatch has taken hold between loans & deposits (too high which are impacting bank profitability). The funds industry is booming within China as it is estimated that by 2010, $1.5 trillion USD will be under administration. The banking sector needs development as the private sector is in need of access to capital particularly for small business, and personal banking with credit cards, mortgages & loans. More recently, foreign banks are now allowed to set up operations in 13 Chinese cities. People’s Bank of China has confirmed strong support for the managed float peg at 8.28 CNY to 1 USD even after WTO implementation. The current wildcard is the exploding money supply growth rate now at 20 percent year over year which may ignite much higher inflation levels thus fueling mortgage & consumer debt, however, PBOC has a goal of 17 percent money supply growth for 2004.
REGIONAL ANALYSIS: Japan, Asia
Other currencies in Asia for the most part have appreciated to the declining USD and CNY - USD peg. The net affect is China’s exports are becoming that much more competitive to the Asian region based on currency differential. Japan with its large current account surpluses, many Japanese corporations are moving manufacturing into China particularly as the Japanese yen (JPY) has been appreciating to the USD. China by maintaining a peg to the falling USD will realize greater competitive advantages as many analysts have forecasted further USD depreciation as several other Asian currencies in the region are most likely to appreciate going forward.
CURRENCY: ISO symbol ‘CNY’, renminbi “people’s currency”, yuan. The renminbi is the Chinese currency used for foreign transactions while the yuan is the domestic currency, yuan transactions are driven mainly by domestic importers and exporters as the yuan is convertible only on the current account. The currency is not freely convertible as it is tightly controlled by the authorities with strict capital controls. The exchange rate regime follows a narrow peg to the US-dollar (‘USD’). At time of review on February 4, 2004, the value of the Chinese currency was at 8.2776 CNY to 1 USD. The renminbi/yuan has remained in an unofficial thin trading band between 8.277 and 8.28 CNY to 1 USD of which Beijing has defended, this band also provides very little incentive for speculation by banks. It is interesting to note that the number ‘8’ is a lucky number for Chinese, ‘828’ an interesting selection which effectively means ‘prosperity and more proseperity’. Some quotations using purchasing power parity have the yuan/renminbi upwards of 50 percent undervalued versus the USD.
CURRENCY HISTORY: in January 1994, China devalued the exchange rate from 5 CNY to the USD to 8.2 CNY reflecting a 40 percent decline with some currency analysts stating that this devaluation was a major key cause or foundation for the 1997-98 Asian currency crisis. Relative exchange rate stability has been prevalent for China since 1995. Historical valuations include: January 1993 at 5.7781 CNY to 1 USD, December 1993 at 5.819, January 1994 at 8.7213, June 1995 at 8.3187, September 1996 at 8.3046, September 1997 at 8.2875, October 1998 at 8.2779, January 2000 at 8.2782, January 2002 at 8.2760, January 2003 at 8.2772, December 2003 at 8.2769. Currency crisis dates include January 1994.
KNOWLEDGE: Oil and yuan/renminbi currency
Soaring demand for energy within China, the nation is now a net importer of oil since 1995. Coal - represents 75 percent of energy needs. China is dependent on Middle East oil, number two consumer of oil now ahead of Japan. Year 2001 oil production at 3.3 million b/p/d, year 2003 consumption at 5.8 million b/p/d. By 2010, oil imports for China are estimated to reach up to 9 million b/p/d.
Hot money going into China as noticed with QTR4 2003 reserves growing at a record $64 billion USD due to its cheap currency and speculation on a yuan revaluation via investing monies through Hong Kong. A cheap Chinese currency has also stimulated China’s exports to compete against other Asian tigers. A key measure of renminbi/yuan undervaluation is the surge in foreign exchange earnings. China is essentially trading goods for USD paper.
If China floats the yuan, Chinese savers may begin diversify into other foreign currencies and banks abroad, how big an impact will this be on the yuan/renminbi exchange rate? Depreciation pressures indeed. This desire to invest abroad in foreign currencies by ordinary Chinese citizens with the arrival of convertibility will counter balance this so-called yuan undervaluation as the yuan may not appreciate as some think as the capital flows will reverse. Capital flight is presently estimated at $20 billion/year USD. China expects to buy $1 trillion USD of foreign goods over the next 3 years as its large growing domestic economy may reverse pressure on the exchange rate. Further, overseas purchases by some large top Chinese corporations will help to reduce pressure to revalue the renminbi, but unlikely to be a major factor. The pillar to financial and national stability is for continued high growth rates to grow the economy as millions of new workers enter the labour force. China holds favorable foreign currency ratings at A2 which is good.
CURRENCY FORECAST: the renminbi/yuan is currently undervalued by approximately 25 percent to the declining USD, some anlaysts have suggested 15 percent due to China soon to be an even bigger importer while other analysts have suggested as high as 40 percent for yuan undervaluation to the USD. The IMF has recently stated the yuan is modestly undervalued, not as radically undervalued as the world may think. In the short term over the next 2 years, risks are prevalent as some areas of the economy are a little dicey including banking bad debts, rising inflation (rising interest rate threat) partly attributed to yuan undervalution although keeping the exports competitive, too much infrastructure, large numbers of workers seeking employment, bubble markets in real estate & stockmarket. Some analysts have talked about a China peak, particularly the property bubbles in Shanghai and Beijing. Are they going to deflate with rising interest rates on the horizon? Over the long term, BI.C is very optimistic and bullish for China with tremendous economic development to continue coupled with an overall higher standard of living. China is also likely to follow the in the footsteps of what happened with Japan where the world’s industrialized nation’s forced the yen to appreciate dramatically during the 1970-80’s to the USD.
As China’s economy advances, the currency itself will inevitably move towards a free floating exchange rate, but this event may take place in stages with a revaluation to the USD more likely as a first step or a greater widening of the trading band for the CNY to the USD. A 25 percent revaluation would repeg the renminbi/yuan to 6.2 CNY to the declining USD. The yuan/renminbi has depreciated to the EUR, JPY, GBP and many other industrialized currencies due to its USD link as the USD has crashed in value over the last 2 years to many currencies. An upwards revaluation (ie. 6.2 CNY to 1 USD) would be deflationary for China which may help to contain domestic Chinese inflationary pressures if domestic inflation rises to over 4 percent in 2004-05. At time of review, BI.C forecasts the USD to fall another 20 to 30 percent to the Euroland Euro, a 25 percent revaluation for the yuan would result in no net gain to many of the industrialized currencies if the CNY-USD exchange link continues to fall as forecasted. The follow up next phase for China is possibly to re-peg the yuan/renminbi to a basket of currencies including the USD, EUR, JPY following a crawling band exchange rate regime (further widening the trading band) then to a managed float as the Chinese banking system strengthens in order to keep financial stability and not to endanger the viability of Chinese banks burdened by significant non-performing loan levels.
The impending convertibility/float of the yuan to take hold with some suggesting a 2007 time frame as China is obliged by WTO membership to freely trade the yuan around the world by 2008. The yuan/renminbi itself will become a major world currency that will survive as the world consolidates down to 10 regional currencies by year 2050. Currency volatlity with a free floating exchange that is fully convertible will indeed be a positive announcement as this signals that China will become a global player in the international currency market. The economy will have advanced to that of “middle development” country status with significant large pockets of first world status in areas, particularly in the coastal regions. China is likely to develop economically peacefully at high growth rates, long term future of immense wealth similar to Singapore, Hong Kong or Taiwan. China to be the world’s ‘Next Great Power’ and future powerful sound convertible currency.
UPDATED: February 4, 2004
