# Presentation: 756139

## May 2006

**May 2006**

- CHINA

**CHINA**
**ECONOMIC AND BANKING **
**UPDATE**

**David F. Verhotz**
**Managing Director**
**International Department**
**KeyBank N.A.**
**May 23, 2006**

**Notes:**
In the eyes of many commentators on the world economy China has turned from hero to villain in the space of little more than a year. In 2003 China’s growth was seen as providing key support to an otherwise still fragile global recovery.
By mid 2004 China had come to be seen as one of the major threats to the global outlook, with much talk of a unsustainable bubble about to burst. In light of these wild mood swings on China, this presentation tries to take a sober look at short and medium term macro outlook and concludes that:
- China’s growth story is not an illusion
- but macroeconomic imbalances have emerged that warrant a swift an effective policy response
- that response has started to emerge
- we can expect a slowdown but there will not be a meltdown.
Economic Soft Landing vs Shock Therapy
	2Q04		9.6% GDP Growth
 	1Q04		9.8% GDP Growth
	4Q03		9.9% GDP Growth
	2003		9.1% GDP Growth
The data should bolster the position of policy makers who are resisting a rise in lending rates as a means of damping overheating sectors. China hasn't increased lending rates since July 1, 1995, when the one-year benchmark was raised to 12.06% from 10.98%. Officials fear an interest-rate increase could smother development of the nascent private business sector, which is needed to re-employ millions of people laid off from state-owned enterprises as a result of market-oriented restructuring. The tightening measures have included lending and land-use curbs, as well as a 0.5 percentage point increase in the reserve-requirement ratio of most commercial banks to 7.5% on April 25.

_**Economic Update**_
-  **GDP Grew 9.9% in 2005**
-        **- $2.9 Trillion**
**          ****- Third Consecutive Year of +9.5% or higher**
**          ****- Investment Led**
**          ****- Has contributed about 60% of China’s GDP over last three years.**
**          ****- Export Growth and Consumer Spending**
**          ****- Fourth largest economy after US, Japan and Germany**
**          ****- Rebalance growth with more focus on consumption**
-  **Trade Surplus of $102 BN**
-          **- Exports were up 28% to $762 BN**
**             ****- Imports were up 18% to $660 BN**

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

-  **Trade Surplus of $102 BN**
-            **- Exports were up 28% to $762 BN**
**             ****- Imports were up 18% to $660 BN**
-   **$819 BN in Reserves**
**             ****- 70% Invested in US$ assets and has helped finance the **
**                ****large US deficit**
**             ****- If China stopped purchasing US$ assets – **
**               ****it would put heavy downward pressure on the US$**

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**China’s Continued Economic Growth**
**      ****    ****-**** ****Pushing up prices for oil, gas and other commodities**
**          ****- Consumption of raw materials equal to USA**
**          ****- Higher inflation rates due to rising oil and food prices**
**          ****- High commodity prices**
**          ****- Excess capacity and over production will keep price increase**
**             ****to a minimum**

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

** ****World’s fastest growing Manufacturing Sector**
**        ****- Large foreign investment in this sector – for USA – more manufacturing       **
**             ****investment shifting to China**
** ****The Service Sector is growing – but – lags far behind**
**   ****the OECD Countries**
**              ****- Future expansion potential for this sector is huge given the growing wealth**
**                ****of the middle class.**
** ****High Tech Sector – Future Potential**
**               **
** ****Agriculture is largest sector – 500 million work in this **
**  ****sector**
**      **
** ****Largest Level of Wealth Disparity**
**          ****- Growing upper and middle classes**
**             ****-  Majority of China’s population live in poverty in the rural areas**

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**                 **
** ****2006 Forecast:**
**     ****-Assumptions:**
**              ****- Government will attempt to slow economic growth**
**              ****- Continued growth in consumer spending**
**              ****- Continued access to export markets**
**              ****- Continued economic growth in key export markets**
**              ****- Renewed focus on agriculture, rural poverty, banking sector reforms**
**              ****- Will remain the leading emerging market in terms of foreign investment                          **
**                 ****potential for the foreseeable future – despite growing competition from **
**                 ****India**
** ****Risks:**** **
**   ****- Protectionism in USA and Europe/Reduced Exports**
**              ****- US$ Depreciates sharply – would lead to decline in global economic growth**
**                ****and reduced export levels**
**              ****- A major SARS or Bird Flu Outbreak**
**         **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**2006 Forecast:**
**	****	****	**_**2005**_**	****   **_**2006F**_
**-GDP Growth****	****	****9.9%****	****    9.4%**
**-Inflation****	****	****1.8%****	****    2.4%**
**-FDI****	****	****	****$60BN****	****    $69BN**
**-Exports****	****	****$762BN****	****    $968BN**
**-Imports****	****	****$660BN****	****    $805BN**
**-Trade Balance****	****	****$102BN****	****    $162BN**
**-Current A/C****	****	****$125BN****	****    $157BN**
**-FX Reserves****	****	****$819BN****	****    $1,025BN**
**-Import Cover****	****	****13.8 mos****	****    14.1 mos**
**-Capital Outflows****	****$240BN****	****    $290BN****	**
**   **
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**       **
**2. **_**Banking Update**_
** ****The WTO agreement to deregulate the banking**
**   ****sector-end of 2006**
**          ****- Fully open banking sector to foreign banks**
**               ****- Allow foreign banks to operate in 25 cities**
**               ****- Provide RMB credit and non-credit services**
**               ****- Currently: **
** ****geographic restrictions on RMB lending for foreign banks**
** ****no geographic restrictions on foreign currency loans**
** ****12/11/06 all geographic restrictions removed**
**   **
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**       **
**Competition**
**      ****- China’s banking system consist of more 30,000 institutions**
**                ****- 3 policy banks**
**                ****- 4 state owned banks**
**                ****- 13 joint stock commercial bank**
**                ****- 155 City Commercial Bank**
**                ****- 626 Urban Credit Cooperatives**
**                ****- 57 Rural Cooperative/Commercial Banks**
**                ****- 238 Foreign bank branches(71 Foreign banks from 20 Countries)**
**   **
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**Strategic Investing**
**        ****- 17 Chinese Commercial Banks have strategic investors**
**               ****- China Construction Bank/Bank of America**
**               ****- Bank of Communications/HSBC**
**               ****- Bank of China/RBS/Temasek Holdings/UBS**
**               ****- ICBC/Goldman Sachs/AmX/Allianz Group**
**               ****- 5 joint stock Commercial Banks**
**                                 ****- Shanghai Pudong Bank**
**                                 ****- Industrial Bank**
**                                 ****- Shenzhen Development Bank**
**                                 ****- Everbright Bank**
**                                 ****- China Minsheng Bank**
**                ****- 7 City Commercial Banks**
**          ****- Foreign banks can own up to 25% but not more than 20% of any one bank **
**   **
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**       **
**Major Commitment**
**         ****- Technical Expertise**
**             ****- Transfer of Management & Technical Know How**
**             ****- Credit Skills/Improved Credit Quality**
**              ****- Make more Competitive**
**     ****- Product Innovation**
**     ****- Corporate Governance**
**     ****- Internal Controls and Mitigation of Risk**
**     ****- Introduce International banking standards and practices **
**           **
** **
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

**       **
**Benefits to Chinese Banks**
**    ****- Effective Method for Bank Reform**
**             ****- Foreign Bank support needed to get central bank approval to expand **
**               ****their business nationally**
**             ****- Help make more competitive in view of increased foreign bank **
**               ****competition – post Y/E 2006**
**             ****- Meet capital regulatory requirements**
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

** ****Initial impact of WTO on Foreign Banks**
**           ****- Increase in number of cities that foreign banks can operate to 25**
**                ****-  Scope of Business Increased to include **
**                                      ****-custodian services**
**                                      ****-insurance**
**                                      ****-conduct RMB business**
**                                      ****-reduce capital requirements to open new branches**
**                                      ****-internet banking activities**
**                                      ****- derivative activities**
**           ****- Encourage foreign banks to develop the country’s central, western and**
**                    ****northeast regions with expedited approval**
**                ****-   Lowered requirements for foreign banks to do RMB business in these**
**                    ****regions**
**	**
**	**
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.

** **
**  ****Banking Sector**
**-Total banking assets  RMB 36.2 trillion**
**-Total assets of foreign banks  $84.5BN**
**-190 foreign banks in Shanghai**
**-PBOC increased 1 year lending rate to 5.85%**
**	****-Growing Money Supply- 16% target for 2006**
**	****-19.7% RMB loan growth in 1Q2006-target 12% fro 2006**
**	****-Commercial Bank NPL’s at 8.6% **
**	****-Issuance of Commercial Paper allowed in May 2005**
**	****-Slow credit growth and tighten liquidity**
**	**
**	**
**              **

**Notes:**
This focus on the consumer sector is not meant to undervalue the external sector’s contribution to development. The opening up of the Chinese economy has been dramatic with exports and imports now accounting for 70% of GDP up from 27% in 1990. FDI inflows averaging 4% to 5% per year have seen China
transformed into Asia’s manufacturing base, with the richer countries increasingly seeing their manufacturing operations – with it their direct exports to the US – hollowed out to China. And the story often heard that FDI in China is the world economy’s largest loss making activity does not square with the fact that outward profit remittances in the balance of payments imply a 6% USD rate of return on the stock of cumulative inward FDI. The penetration of Chinese exports into world markets has been profound. For example, Chinese sourced
imports now account for around 12% of total US goods imports – this is larger than Mexico, a country that has enjoyed the benefits of NAFTA. While the direct value added contribution of foreign invested enterprises may be somewhat limited – as evidenced by their minimal job creation – the indirect effects through technology transfer have been important in domestic industrial development. Moreover the reliance on FDI rather than international borrowing to finance export led growth has substantially reduced China’s vulnerability to external shocks.
Probably the most striking difference between China and the Asia crisis countries is the strength of its external finances. China recorded a current account surplus of USD46bn last year, 3.3% of GDP. Foreign exchange reserves of USD440bn are more than twice as large as China’s gross external debts. China’s international liquidity ratio is over 800%, just about the highest of any country rated by Fitch. Moreover capital controls limit the potential for domestic capital flight. So while China shares some of the structural deficiencies seen in the Asia crisis economies prior to 1998, its external vulnerability is very much lower. It was primarily the latter that proved the catalyst for transforming slowdowns into meltdowns in Indonesia, Thailand and Korea in 1998.