China has indicated in recent days that more interest rate cuts are likely in order to stimulate economic growth. New statistics released showed slowing retail sales, sagging investment and a declining prices. China's retail sales last month grew by just 5.3 per cent to 236.4 billion yuan, the slowest growth for five years. Investment in new plant and equipment by SOEs (state-owned enterprises) in May totaled 475 billion yuan, a rise of 17.6 per cent on the May 1998 figure, also indicating a slowing down. The retail price index for May showed a fall of 3.5 per cent, the 19th consecutive month of decline and an indication that Chinese consumers are reluctant to spend. Last week, China cut its interest and deposit rates for the seventh time since May 1996. The fact that deposit rates were slashed by 1 per cent or more while lending interest rates were trimmed by an average 0.75 per cent was a signal that the government is keen to promote spending. The government has also been trying to promote a stock market rally to show confidence in the economy and encourage spending. Although China is aiming for a growth rate of 7 per cent that would be considered high by current Asian standards, the economy has many structural problems. Some of the bloated state-owned enterprises are preparing to get rid of up to 30 to 40 per cent of their workers in efforts to stay competitive. Other reforms will increase prices for basic goods like housing, education and medical care and also will depress spending. China's exports have also been sluggish and slowing and it was possible China would provide bigger tax rebates to boost exports in the context of an over-valued RMB. Economists expect that more aggressive cuts in interest rates will be an essential part of new stimulatory measures, which will also have to include a looser monetary policy, aggressive macroeconomic expansion and probably a fiscal stimulus. As Japan has found, and it is hard to encourage people dismayed by job cuts to spend by lowering interest rates alone. Japan has cut interest rates to its lowest levels ever and bank deposits offer effective negative interest rates, but consumer confidence has been remained stubbornly depressed. Ironically, structural reform programs are deflationary contradiction reflation needs. The policy contradiction between maintaining a fixed exchange rate and boosting economic growth is exacerbated by worsening balance of payments (BOP). State sector reform has increased job security and loss of income to many. The scrapped social welfare system is helpless to help displaced workers, causing consumers to become ultra cautious. Net saving deposits are growing at a rate of 18%, despite low deposit interest rates. China has no consumer credit market, thus households cannot accelerate or defer spending as interest rates change. Overcapcity caused deflation validates consumer belief that delaying purchases is sound wisdom. The non-state sector, accounting for 50% of total fixed asset investment, plagued by over-capacity and falling prices, cannot absorb or attract new investment, while real interest rate remains high. Too much reform will put pressure to devalue the RMB. If the People's Banks of China (PBOC), the central bank, fall into payment deficits sharply either through trade current account deterioration, or a fall in net FDI inflow, the PBOC, to compensate for a rise in the supply of RMB in the international market, would have to tighten domestic money supply (the flip side of draining foreign reserves), thus neutralizing reflation measures. The aim of reform is to shift economic fundamentals. A fixed exchange rate is basically inconsistent with this policy objective. An over-valued FER will transfer wealth from efficient exporters to inefficient domestic enterprises. Reform aims at export switching from sunset to sunrise industries to enhance external competitiveness. A market set FER can help absorb external trade shock. So a overvalued FER is a fact in tax on exports and a subsidy for foreign debt ridden domestic borrowers. There are conflicts with China's three economic objectives: a high growth rate, fast paced reform and a FER. That is the reason there are persistent speculation of the RMB devaluing. Henry C.K. Liu
