Distinguished Speaker Seminar by Dr. Yu Yongding -PRC's Macroeconomic Management: Issues and Solutions

Dr. Yu Yongding, Director-General of Institute of World Economics and Politics of China, addressed ADBI staff and invited guests on PRC’s macroeconomic management issues. His lecture focused on RMB flexibility, foreign exchange reserve management, asset market developments, monetary policy and financial system soundness in the PRC.

Over the past 26 years, the Chinese economy has been growing very fast, registering an average annual growth rate of more than 9.6 percent. China is still posed to maintain a high growth rate for another decade; however, it is also facing serious challenges, such as deterioration of environment, exhaustion of energy resources, widening gap between the rich and poor and different regions, and external imbalances.

Dr. Yu stated that after 26 years of growth, it is time to adjust the growth strategy. In particular, export promotion and policies to attract capital that resulted in market distortions should be dismantled. Some policies also need to be implemented to simulate domestic consumption. He pointed out that China’s current economic situation is characterized by imbalances and instability. Symptoms include the continued increase in current account surplus, soaring equity prices, inflation rate approaching the implicit target, and a significantly higher growth rate of investment compared to GDP growth rate.

A pressing issue at present is the equity bubble. He asserted equity bubble is the most important threat to China’s economic stability at this moment. When the bubble bursts, social consequences will be serious, affecting a large number of small investors. There are 100 million retail accounts in China as of May 2007.

Dr. Yu argued that excess liquidity is the fundamental cause of the equity bubble. The main causes of the excess liquidity are: accumulated money stock that takes the forms of household deposits and increased reserve money caused by government intervention in the foreign exchange market, resulting in the twin surpluses. Policy measures dealing with the excess liquidity include increasing reserve requirement, selling central bank bills to commercial banks, increasing interest rates on loans and deposits, and appreciating the RMB.

He also stated that the effectiveness of the above policies is constrained by policy makers’ adherence to a stable exchange rate. One way to solve this problem is to adopt a more flexible RMB exchange rate regime which considers the movement of the current account surplus and inflation, while examining assets bubbles, growth of FAI, sustainability of sterilization operations, and effectiveness of the management of the capital account.

Furthermore, he suggested that RMB should be revalued to help reduce the trade surplus. It should provide enterprises impetus for upgrading their positions in the value chains; improve terms of trade; reduce trade frictions; and share the burden of reducing excess liquidity.