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Cablegate: China: Bank of Japan Representative Discusses Chinese

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UNCLAS SECTION 01 OF 02 BEIJING 000637

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STATE FOR EAP/CM AND EEB/OMA
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STATE PLEASE PASS USTR FOR STRATFORD

E.O. 12958: N/A
TAGS: ECON EFIN PREL EINV CH JP
SUBJECT: China: Bank of Japan Representative discusses Chinese
economy

SUMMARY
-------

1. (SBU) On February 4, Finatt Minister Counselor and Econoff
exchanged views on the Chinese economy with Kiyoyuki Seguchi, Bank
of Japan's (BOJ) Chief Representative in China. Seguchi predicted
that China's GDP -- buoyed by growing fixed asset investment and
rising domestic consumption -- will likely grow by more than 10
percent in 2008 even as exports slow in the wake of the subprime
crisis. He said inflation will remain a top government concern and
forecasted and predicted 6 percent average CPI growth rate for the
first half of the year. On the renminbi (RMB), Seguchi stated he
expects continued gradual appreciation against the U.S. dollar,
reaching an optimal point between 5.5 and 6.5 RMB/USD this year, but
added that while a 6.5 RMB/USD exchange rate would probably be
acceptable to Chinese leaders, a 5.5 RMB/USD rate would be "less
palatable." Commenting on the domestic economic impact of the
Japanese yen's rapid appreciation against the U.S. dollar in the
mid-1980s, Seguchi said policymakers' insistence on maintaining low
interest rates well into 1989 -- not the yen's appreciation itself
-- caused the development of a "bubble economy."

GDP growth will remain strong in 2008
-----------------------------------

2. (SBU) Seguchi estimated that despite a possible decline in
exports due to the U.S. subprime crisis, China's GDP growth will
exceed 10 percent in 2008, although growth could be slightly lower
if commodities prices rise sharply. Seguchi noted that between 2005
and 2007, China ran a large trade surplus, which boosted GDP by
about two points. Even if the trade surplus narrows due to slower
growth in exports to the U.S., Japan, and Europe, China will
maintain an approximate 9.4 percent GDP growth in 2008, he argued.

3. (SBU) Seguchi explained that governmnt fixed asset investment
(FAI) and rising domestic consumption could make up for slower
export growth. He noted that historically, government FAI has risen
following changes in provincial and national level leadership. With
new provincial administrators in place across the country this year,
more public funds will be channeled into infrastructure and
development projects. The central government views the development
of Western China as a top priority, Seguchi said, and investment in
the West and in areas affected by recent snowstorms will likely
continue to expand. Seguchi explained that domestic consumption
will also increase this year due to job creation, higher wages, and
rising farm incomes stemming from higher agricultural prices.

CPI growth will increase at least until mid-year
-----------------------------------
4. (SBU) Seguchi expects CPI growth to hover around 6 percent until
June before declining throughout the remainder of the year. He
noted, however, that this forecast could change quickly and recalled
that last year CPI increased rapidly during the summer months -- by
1 percent each month in June, July, and August. Recent snowstorms,
he explained, have already caused short-term inflation and may also
trigger longer-term inflationary expectations. Such expectations
could drive wages upward, in turn fueling further CPI growth.

Renminbi will appreciate gradually
----------------------------------

5. (SBU) Seguchi said he encouraged his contacts in the Chinese
government to allow the renminbi (RMB) to appreciate gradually
against the U.S. dollar following the October 2007 National Party
Congress (NPC), noting that rapid appreciation before the NPC would
have been politically unfeasible. He acknowledged the possibility
that gradual appreciation could lead to currency speculation
opportunities and excess foreign currency inflows, but he argued
that a big jump in RMB appreciation would be too risky for the
Chinese government, as the possible short-term destabilizing effects
could run counter to the Hu Administration's "harmonious society"
agenda. Seguchi stated that if the RMB appreciates too quickly,
exporters could face bankruptcy and domestic farmers would be hurt
by a rapid increase in cheaper agricultural imports. Weakened
manufacturing and agriculture sectors could pose a threat to the
Hu/Wen leadership, he explained.

6. (SBU) In Seguchi's view, the USD/RMB exchange rate should reach
an optimal point between 5.5 and 6.5 RMB/USD this year. He
explained that while a 6.5 RMB/USD exchange rate would probably be
acceptable to Chinese leaders, a 5.5 RMB/USD rate would be "less
palatable," as it could hurt exporters and farmers. Seguchi stated
that if the RMB/USD exchange rate reaches 6.5 RMB/USD by the end of
June and the economy remains stable, the RMB should continue to

BEIJING 00000637 002 OF 002


appreciate in order to prevent a build up of excess liquidity, a
problem that he considers much larger than inflation or
unemployment.

Japan's bubble economy not attributed to yen appreciation
----------------------------------

7. (SBU) Seguchi reported that he is often asked by Chinese contacts
whether the Japanese yen's rapid appreciation against the U.S.
dollar following the 1985 Plaza Accord contributed to Japan's
economic woes in the late 1980s and early 1990s. In Seguchi's view,
policymakers' stubborn commitment to loose monetary policy, not the
yen's appreciation, is to blame. He argued that although the yen's
appreciation had an immediate negative effect on exporters,
companies producing for Japan's domestic market saw a rapid rise in
profits. By 1986, macroeconomic indicators revealed that the
economy had already begun to recover from the 1985 appreciation
shock. But after years of advocating export-led growth, the
Japanese government continued to prop up exporters by keeping
interest rates low until 1989. This contributed to asset price
inflation well beyond GDP growth rate. Seguchi noted that between
1985 and 1987, real estate prices in Tokyo rose 300 percent;
meanwhile, annual real GDP growth over the same period was about 5
to 6 percent.

RANDT

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