Examination of Witnesses (Questions 40-59)
8 FEBRUARY 2005
MR RAY
BARRELL, DR
GERARD LYONS,
MR PETER
NIGHTINGALE AND
DR LINDA
YUEH
Q40 Mr Fallon: Just before we go onto
how they might respond in China, let us just be clear about whether
the renminbi is undervalued or not. Dr Lyons?
Dr Lyons: In my testimony I referred
to China as a Robin Hood and Goldilocks and Superman economy.
The Robin Hood, aspect, I think, is relevant here. Here in the
West we tend to think of China as having huge trade surpluses,
as it does with Europe and the States, but it is important to
remember that China is having a Robin Hood effect in other regions,
having a big boost to activity, and it has a huge trade deficit
with the rest of Asia. So when we talk about the currency and
the prospects for the Chinese currency it is important to stress
that it does not necessarily have to move in the same direction
against all currencies in the future. I think there is a case
for the Chinese currency to be stronger against the G7 currencies
but in time, or in the near-term, it could weaken further against
Asian currencies. It is important to stress that financial markets
have moved from one extreme to the other on this. In 2001 the
markets were calling for China to devalue, and last year the same
people were calling for China to revalue. Fortunately, at Standard
Chartered we have been consistent in arguing over those years
that there was no case for China to change its currency policy.
I think there is a case now, partly because of what has happening
in terms of the external enviroment, in terms of the dollar's
continued trend downward, but also domestically inflation pressures
are starting to appear in China; producer prices are picking up,
and consumer price inflation is becoming more evident. I think,
therefore, in terms of currency policy, one of the lessons from
Japan in the late-80s is that you should set your currency policy
to suit domestic needs and not just to suit the US or external
circumstances. So I think Chinese currency policy should be set
to ensure that China continues to achieve strong domestic growth.
On that basis, I would say that there is now a case for revaluation,
and I would stress that the case is very much based on gradualism.
At Standard Chartered we constructed a Chinese currency barometer,
and we have taken into account sustainability, competitiveness,
and overall economic performance. On that basis we would say that
there is now a case for revaluation but the important point to
stress is that I think it should be a gradual revaluation. I certainly
agree with Mr Barrell's point that if, overnight, currency controls
were lifted in China it is just as likely the currency would go
down as up, and therefore I think the Chinese are sensible and
realise this. The very fact that there is such an intense debate
going on in China highlights the fact that there are many different
factors to consider on this.
Q41 Mr Fallon: How do you think the Chinese
authorities will or should respond?
Dr Yueh: I think on renminbi valuation,
in the long run it is clear that the exchange rate should be determined
by the balance of payments, but in the short run the economic
models may find it very difficult to actually establish precisely
what the value ought to be, and I think that is the crux of the
problem. I think the view is, because China has import restrictions
and there are distortions on the import side, it is likely that,
vis-a"-vis the dollar and given the rapid decline
of the dollar, there is probably an imbalance in the exchange
rate, though it has not been inflationary. What is inflationary
in China is often volatile food prices. So, from that end, the
concern is not currently there but there is a concern that it
is very expensive to maintain a fixed exchange rate; it is costing
the People's Bank of China a reported $600 million a day to stabilise
the renminbi. That even of itself is expensive and not particularly
sustainable. So I think the feeling now is that if, as Mervyn
King has called for, these discussions can take place in private
so that speculators do not erode any immediate value, then it
is likely we may see a move in terms of what the Chinese authorities
would feel to be consistent with their growth strategy towards
thinking about the effective exchange rate—not the bilateral
but the effective exchange rate. If China moved to a trade-weighted
basket of currencies, for instance, it could take into account
the fact that its trade is increasingly with the other Asian countries
which are following its lead, but it tends to run a trade deficit
with them as opposed to a trade surplus with the rest of the world.
So, moving the RMB gradually towards a peg with a trade-weighted
basket of currency would help in terms of stabilising the currency.
However, I should finally say that their main concern is of macro-economic
instability. I mentioned earlier that one of the biggest concerns
is the twin crisis: that if you had a crisis in the currency market
it can transform into a crisis in the financial market. This is
what we saw in the Asian financial crisis; this is what we saw
in the crisis that spread through Russia, Argentina, Turkey, and
earlier in Mexico in 1994. These are destabilising crises, if
China were to move too quickly on its currency, despite the fact
that it has capital controls, and we know those are being eroded
by the measures of the amount of hot money going into the economy,
then China is very worried about macro-economic instability resulting
from a brash move on its currency.
Mr Nightingale: China's financial
structure is extremely underdeveloped and it will be very cautious
about doing anything that its own structures might not be able
to cope with. Basically, it is underdeveloped because it has only
been developing for the last 20 or 25 years, and literally just
does not have enough people well-trained to undertake the jobs
that need to be done. It has got to train those people up.
Q42 Mr Fallon: Ray Barrell, could you
add something on the issue of very large foreign exchange reserves
that China has built up? Can these be reduced without disrupting
currency markets generally?
Mr Barrell: The build-up of very
large foreign exchange reserves, I think, has been partly due
to the peg, and partly intentional on the part of a number of
authorities throughout the region. There were, 8 or 10 years ago,
some discussions of setting up an Asian Monetary Union and an
Asian Monetary Co-operation area, and I think central bankers
in much of, at least, that part of the Pacific Rim still have
it at the back of their minds. The build-up in reserves is there
for a very long-term reason, perhaps. However, the build-up of
reserves recently has also been partly associated with trying
to maintain a peg. It is very difficult to know what central bankers
are now doing, but there is some evidence from US statistics that
East Asian and, especially, Chinese central bankers are no longer
so willing to buy US Government debt. US Government debt was the
thing that the reserves were in, and in the last few months probably
since about September/October there has been a significant decline
in demand for US Government debt by central bankers in East Asia.
That may be one of the reasons for the further decline of the
dollar. The Chinese almost have a dual problem: they are one of
the reasons why the dollar has not fallen so much, they have been
buying assets which perhaps were not the best ones to buy in order
to prevent that, and as soon as they stop buying those assets,
US Government securities, the dollar falls further. The build-up
of reserves has, I think, been partly intentional and partly accidental.
It might be wise to dispose of them but the disposing of them
pushes down the dollar further, so it is a very difficult situation
they have got themselves into. They may have started that disposal
now; it is impossible for us to know that.
Q43 Mr Fallon: Finally, from me to Dr
Lyons: what else do the Chinese need to do if they are to move
to a more flexible exchange rate?
Dr Lyons: I was just going to
add, on the previous question, that it is interesting to notice
that a decade ago Asian central banks held one-third of global
currency reserves, and now they hold two-thirds of global currency
reserves. It is not just the Chinese, it is across the whole region.
Ray is completely correct, after the Asia economic crisis I think
South Korea used the phrase: "We were solvent but not liquid."
Countries decided to build up reserves to add liquidity, then
they decided to keep their currencies competitive. So there is
a valid economic reason, and the Bank for International Settlements,
particularly in Hong Kong, has done a lot of work that says that
maybe these countries have not reached yet the ideal level of
currency reserves. There has been passive diversification. You
can look at the amount of US Treasuries that have been bought
as a percentage of the increase in reserves, so these central
banks have not yet sold dollars but they now put less of their
new money into dollars than before. So it is passive, not active,
diversification. What does China need to do? I think what they
need to do is move gradually. The way I describe it is in three
stages: within that, first, they need to move to a wider band;
second I would suggest that they need to move to a trade-weighted
currency basket and, third, they need to then clearly float. To
get to the third stage you need to have convertibility on your
capital account, but maybe what is more relevant for the current
debate is what you need for the first and second stages. You need
to have effective hedging mechanisms in place for companies within
China to be able to hedge future currency exposures. Also, you
need to be able to make sure that people can trade the currency
and that domestic banks who previously had been used to a peg
can cope with more flexibility in the currency. So the bottom
line is you need to introduce more liberalisation into your domestic
financial system. As I say, it is very important that China moves
gradually. As I say, it is a three-stage process, and in terms
of helping that process (coming back to your question) it is very
much a case of introducing liberalisation so that not only the
financial sector but also the domestic corporate sector can cope.
Q44 John Mann: What are the biggest opportunities
in the next 15 years for UK plc, in terms of China?
Dr Yueh: It is services. Currently
the UK runs a trade deficit with China in manufacturing, but it
actually runs a trade surplus in services. The recent movement
of Chinese firms to raise capital overseas provides more opportunities
for trade in that they are seeking financial expertise and expertise
in corporate governance matters. These are areas in which the
UK is well-placed to help. I think that is going to be what we
see in the next 15 years.
Mr Nightingale: Certainly from
what we see now, in terms of the growth and interest of British
companies in China, the majority of these companies are small
and medium-sized and the majority are in service-type sectors.
High-tech and other service sectors, I think, will be the future
for firms in this country.
Dr Lyons: I would just highlight
two areas. First, we need to make sure that the UK is an attractive
place for inward investment. In the last decade, when the Japanese
invested heavily in the UK, it was not just in terms of setting
up manufacturing plans, it was research, design and development,
and I think the UK, particularly given its educational expertise,
should be attractive in that respect. The second area is, clearly,
and I see it directly from my own field, the financial sector.
British banks, the British financial sector, has phenomenal opportunities
because as the Chinese economy evolves the financial sector in
China will become much bigger and this is where the UK still has
one of its main competitive advantages. We, as a bank, have been
in China 146 years, but the interesting thing is that it is going
to be an attractive place for new banks to go into as well. So
those are at least two points which reinforce what Peter and Linda
have mentioned.
Q45 John Mann: What are the key barriers?
Dr Yueh: The service sector in
China is opening very quickly, in a sense. The WTO accession terms
means that China is going to liberalise financial services, banking,
insurance, education and law—it has been described as breathtaking—but
the agreement to do so does not necessarily mean that it is going
to do so quickly. So, for instance, you are going to find that
one of the main barriers will still be geographic because the
nature of the decentralised system in China is that provinces
have a great deal of control over economic investments into their
areas. The breaking down of those barriers within China will take
time. They are beginning to do so, such as the creation of the
Pan Pearl River Delta, which is intended to link the southern
provinces with Hong Kong and Macau. So there are moves to reduce
some of these barriers, but I think some of the other barriers
are the ones that we have seen: the incompleteness of the legal
system, a lack of enforcement of property rights, and lack of
transparency in the regulatory structure. I might add, on the
last point, there are very few things within WTO rules on international
economic law that are truly enforceable, and transparency is actually
one of them. If the laws of an accession member state are not
transparent that is actually grounds to bring action, and I think
for that reason we will see improvements in terms of these barriers.
Mr Nightingale: I think another
barrier is lack of knowledge in this country. We still need to
provide a lot of education in this country about the opportunities
in China and how actually we get into China.
Q46 John Mann: Who is "we"?
Mr Nightingale: UK plc. The China-Britain
Business Council, the Government—a number of different organisations—but
we do need to increase.
Q47 John Mann: Let us take the China-Britain
Business Council as an example, then. How does your grant compare
to competitor bodies from other countries?
Mr Nightingale: I cannot give
you an answer to that because I do not think we know, but we certainly
feel that we need to be reaching out more in our own regions in
the UK so that we reach more companies to tell them about what
the opportunities in China are, and we need to be able to help
those companies when they get to China—ie, we need to have
more reach in China itself.
Q48 John Mann: Who has got the most effective
trade body in China? Is it us?
Mr Nightingale: I think we are
quite competitive. There is no doubt that the countries that are
closest to China, the Hong Kong people, the South Koreans, the
Taiwanese and the Japanese, of course, have huge advantages in
terms of the network that they have with China already.
Q49 John Mann: Mr Barrell, how are we
placed?
Mr Barrell: How we are placed
depends on what we produce. I think the places where Europeans
can enter the Chinese market effectively are in things like telecommunications
equipment of various sorts. Investment goods are sought; a lot
of German companies have been successful, and the Finns have been
very successful in telecommunications. The other area, perhaps,
more relevant for the UK is aerospace. Those are the things that
do travel long distances. We are a reasonable producer of aerospace
products (that is aeroplanes). We may find that we can increase
share there, but the goods that we tend to produce are not the
goods that the Chinese are particularly demanding at the minute.
This is not necessarily a bad thing. If the Germans sell goods
to the Chinese they then import goods from the British, but at
the minute it is investment goods (which is particularly Japan
and Germany) and telecommunication goods (which is, to an extent,
the UK but much more Finland, Sweden and Japan). So there are
certain countries that are producing the goods that this economy
needs. One must remember, for instance, there are some very interesting
things the Chinese can do, they can leap the whole of the existence
of the fixed line telephone system and move the economy over to
small handset telecommunications. That is not something where
we are particularly strong. So there are opportunities there,
but they are not necessarily our opportunities.
Q50 John Mann: What about nuclear technology?
Mr Barrell: That is beyond my
ability to comment, I am afraid.
Q51 John Mann: Do the Chinese want to
build lots of nuclear power stations? We are quite good at doing
that.
Mr Nightingale: I think they do,
but it tends to be French technology that they use, or even, in
today's newspaper, it appears to be their own technology and South
African technology that they are developing.
Q52 John Mann: But why?
Mr Nightingale: I suspect because
that is more advanced.
Q53 John Mann: Dr Lyons, who is better
than us in terms of our trade bodies and missions? Where are we
in the league tables, in terms of—
Dr Lyons: I do not know about
that aspect, but in terms of the trade figures this touches on
some of Mr Barrell's point about the capital demands from China.
In terms of the league table, Britain does not export as much
as Germany or France to China, which is quite interesting. I think,
the last time I looked at the figures, even though our value of
trade to China is going up, our competitive positioning is maybe
not as high as we would like it to be. By default we have moved
out of a lot of manufacturing sectors. I think the key point is,
really, coming back to the Treasury's own document, that the UK
needs to be flexible, innovative and entrepreneurial. The question
we have to ask ourselves is: are we as innovative, flexible and
entrepreneurial as we should be? We need to make sure that policies
are in place to ensure that we are.
Q54 Chairman: Just a few questions to
wind up with. The weakness of the Chinese banking system has been
mentioned. How long do you think it will be before the Chinese
financial system is operating on a solid, sustainable basis? Is
full Western access to the Chinese financial markets likely to
have to wait until that exercise has been completed? Any one person
on that?
Dr Lyons: As a banker, I think
it is important to stress that the Chinese financial sector has
clearly started to improve. The creation of the Chinese Banking
Regulator and Commission in 2003 under Liu Mingkang has had a
big impact. There is now a sounder supervisory system; the banking
network is improving and foreign banks are bringing expertise
in terms of necessary expertise into the sector. The important
point is to have some sort of patience. The pace of change could
take far longer. When you meet regulators and people at the centre
in China their expertise is phenomenal, but we have to accept
that China is a very diverse economy, and the changes will take
a long time.
Q55 Chairman: On that point, are Chinese
regulators playing a major role in slowing the entry of overseas
players into the Chinese financial services market?
Dr Lyons: As Standard Chartered,
we have just bought a 20% stake in Bohai Bank, we have worked
with the Chinese authorities and we have seen other foreign banks
buy stakes in the Chinese banking sector, so there is nothing
to suggest that they are slowing it. If you look at the data,
the number of foreign banks which have set up positions in China
is increasing. I think a lesson from the Asian financial crisis
is very valid here: economies across Asia opened up their financial
sectors extensively in 1997, and the lesson from that is that
you need to change your financial sector at a pace best suited
to your domestic economic needs.
Q56 Chairman: The Deputy Prime Minister's
China Task Force recently identified five key areas—energy,
financial services, water, health care and ICT—in terms
of building UK commercial links with China. Is that list exhaustive
or are there any other areas that you think should be on the list
that demand equal focus? Education and legal services have been
mentioned.
Dr Yueh: I think education is
important. I think there are quite a few other areas where I would
like to see more collaboration, but I think legal education is
another one—clinical legal education—extending the
type of system and expertise that we have gained over the years.
I think, also, research and development. That could fall within
the ICT sphere, but research and development can actually be broader.
I think that is another important area where there could be a
good sharing of expertise.
Mr Nightingale: I do not think
these are meant to be exhaustive, and water is partly environmental,
I suppose, but the whole environmental sector is a very big sector
for China, and I think we have some expertise there that we probably
can do more with in China.
Q57 Chairman: The China Task Force stated
that we need to combine and increase currently disconnected resources
and deploy them more effectively in the UK and China. What is
happening to tackle that problem? Will we wait till we get to
China to ask that question?
Mr Nightingale: Probably that
refers to the China-British Business Council and the way we work
with the government services in China. One of the thrusts of that
particular recommendation was to make sure that we do not overlap
with them, that we demarcate the work that we do and the work
that government does in China. We have made quite a lot of progress
in doing that, and that is in the process of being implemented
now. So the companies that want help in China know where to go
to get it and they do not find that two organisations are doing
the same sort of thing and, therefore, it is complicated or expensive
to get that sort of help.
Q58 Chairman: Mervyn King, amongst others,
has been talking about the reform of international institutions
such as the G7, the IMF and the World Bank. Is there an equivalent
pressure for change from China? What is the US view of reform
in that area?
Dr Lyons: I do not know what the
US view is. I think there is a regional aspect as well as a global
aspect here. Within Asia, China is playing a much more important
regional role, and we are seeing regional groupings become more
important. The ASEAN + 3 (Association of South East Asian Nations
plus the three, being Japan, South Korea and China) has become
very important. Also, when one visits Asia it is very evident
that APEC is becoming very important (the Asia Pacific area).
Europe is seen as marginal. In terms of the global picture, I
think there is very much a clear case for global institutions
to change because if you are to address the big, growing economic
issues of the future then you need to have membership that is
able to address those. For instance, G7 needs to evolve to include
the emerging economic superpowers of China and, ultimately, India,
particularly for currency issues. It is very difficult to push
people off and a new forum may emerge, and G20 is seen as very
important.
Q59 Chairman: Will there be G10, from
a G7?
Dr Lyons: Whatever number you
want.
Dr Yueh: The European Union, in
geopolitical terms, is actually quite important for China. There
have been declarations that China is very keen for the European
Union to become if not its top trading partner then certainly
a rival to the United States. I think we ought to see this as
indeed a shift as there are political reasons why many countries
may not want to be seen simply tied to the United States. I think,
in terms of expanding something like the G7, there are economic
reasons for doing so because China is already larger than half
of its members, but there are also political reasons. When Russia
was added as a member of the G8 in the 1990s it was due to a complex
set of reasons, not because of its economic prowess. So I think,
in terms of China's impact, and indeed some of the other emerging
economies' impact on world markets, if the G7 finance ministers
or leaders need to discuss the global economy and these economies
are having an effect, then I think there is a reason for including
them in an increased grouping. What I think is actually harder
is the question in terms of the United Nations Security Council.
There is a lot more resistance to changing the constituency of
that, but China is already a permanent member so it is not particularly
relevant for China, but it is relevant in that it is thinking
about how we reconstitute, who the major players are and how we
define the major players. Is it just based on economic power?
Or, surely, there must also be other considerations for why we
would want international fora to be representative of a wider
set of countries.
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