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Cablegate: World Bank's Ifc On Asset Bubbles, Housing Costs, Economic

VZCZCXRO1426
RR RUEHGH
DE RUEHCN #0005/01 0060732
ZNR UUUUU ZZH
R 060732Z JAN 10
FM AMCONSUL CHENGDU
TO RUEHC/SECSTATE WASHDC 3666
INFO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHOO/CHINA POSTS COLLECTIVE
RUEHCN/AMCONSUL CHENGDU 4387

UNCLAS SECTION 01 OF 03 CHENGDU 000005

SENSITIVE
SIPDIS

STATE FOR EAP/CM

E.O. 12958: N/A
TAGS: ECON EIND EFIN PGOV CH
SUBJECT: WORLD BANK'S IFC ON ASSET BUBBLES, HOUSING COSTS, ECONOMIC
RESTRUCTURING, AND THE CHINESE EDUCATION SYSTEM

REF: A) 09 CHENGDU 271, B) 09 CHENGDU 310, C) 09 BEIJING 665

CHENGDU 00000005 001.2 OF 003


1. (U) This cable contains sensitive but unclassified
information - not for distribution on the Internet.

2. (SBU) Summary: The head of the World Bank's International
Finance Corporation (IFC) office in Chengdu, a PRC national with
a patriotic bent, acknowledged that China faces possible asset
bubbles, but was confident that China's "strong and
technocratic" government would intervene effectively if the
signals of overheating became too severe. Rapidly rising urban
housing prices are here to stay for the coming few years, he
believes, as they are an unavoidable, long-term aspect of the
nationwide, structural shift in the population from rural area
to urban centers. The IFC is trying to push Beijing to address
the lack of affordable housing for moderate income households.
China does have overcapacity in several industries, but the
emphasis on mega-projects by local politicians, many of whom are
engineers, will make reducing overcapacity more difficult. Over
the next 10-20 years, China will need to restructure its economy
so that it has a significantly higher share of knowledge-based
services, especially research and development. However China's
"terrible" educational system, which promotes copying and
pasting over creative and independent thought, is the largest
impediment the country faces on this front, our IFC contact
said. End summary.

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Asset Bubbles: "Signs Are There",

But Government Intervention Will Address

----------------------------------------

3. (SBU) In a December 17 meeting with Consul General, the

head of IFC's Chengdu office, Lai Jinchang, discussed the
question of whether stimulus policies have created asset bubbles
in the Chinese economy. Lai noted the "staggering" amount of
credit the government injected into the economy in 2009,
contrasting the estimates of around 9.3 - 9.4 trillion RMB (USD
1.3 - 1.4 trillion) with the "normal" annual figure of less than
4 trillion (USD 588 billion). This has certainly caused
inflationary pressures - he particularly noted increased prices
in iron and steel, petroleum products, electricity, water,
edible oil, and produce. However, Lai, perhaps in part out of
patriotism and bureaucratic survival instincts, made the
ambivalent prognosis that, although "The signs of an asset
bubble are there," the economy was not yet experiencing
"genuine" asset bubbles.

4. (SBU) Overall, Lai said he was not worried about the possible
emergence of asset bubbles because of the Chinese government's
capacity to track the situation and take timely and effective
action. If credit needs to be further reigned, the government
will just set a new quota and make it happen. In particular, he
highlighted the December Communist Party of China (CPC) Economic
Work Conference, where participants emphasized the need for some
cooling down of credit. He also noted the Central Bank of
China's public stance on moderating credit in the coming year.
Lai assessed the basic economic policy stance going into 2010 as
unchanged, continuing to emphasize a favorable monetary policy,
but with the size of the credit expansion significantly reduced.

Overcapacity in Number of Industries:

Local Politicians Contribute to the Problem

-------------------------------------------

5. (SBU) Asked about the European Chamber of Commerce in China's
recent report on overcapacity in China, Lai said he had not yet
read the report, but agreed that overcapacity was a problem in a
number of industries. He highlighted the bio-energy, wind and
solar industries in particular, noting that they had grown
rapidly in recent years as a result of a surfeit of subsidies,
and would likely face a period of restructuring. He also

CHENGDU 00000005 002.2 OF 003


expected the industries targeted in the central government's
ten-industry stimulus plans (Ref C) to develop overcapacity.

6. (SBU) Regardless of concerns about national overcapacity,
local politicians, such as in inland provinces of Southwest
China, will continue to rely on investment in large projects to
boost local GDP and further their own prestige, Lai said. He
agreed that Leshan in Sichuan, where the city is planning three
billion USD investment in transportation and industrial
infrastructure (see Ref B) may be such a case. "They are mostly
engineers so they understand mega-projects, but they don't
understand the law," Lai stressed, further explaining that he
views most Chinese leaders as lacking an understanding of
institution building. However, he said, the emphasis on large
projects to boost GDP figures is "not all bad." After all,
"they have been doing it for decades" and there have clearly
been some benefits.

Inflated Housing Costs: Here to Stay as Urbanization Continues;
Moderate Income Households Most Severely Affected

--------------------------------------------- ------------------

7. (SBU) While housing prices have certainly seen some increase,
this is not a major issue in cities such as Chengdu, Lai felt,
as prices generally remain within reason. Discussing the
Beijing and Shanghai markets, he described the housing prices as
"a little scary" and in many cases "totally out of reach" for
the vast majority of Chinese citizens. Nevertheless, investment
in the hotter housing markets - for those who can afford it --
will likely remain secure for a while to come, he predicted.
Although purchase prices often far outstrip realistic rental
incomes, the capital gains on most housing purchases will
continue to make the purchases worthwhile. The apparent excess
of new empty apartment buildings in urban areas, along with
price increases, was not necessarily irrational, Lai asserted.
Rather, he believed these trends to be driven by the long-term
process of urbanizing the Chinese population - a process that
still has years to go. Separately, Lai asserted that one
problem with including housing prices in China's Consumer Price
Index (CPI) is that the commercial housing market was immature
and just over a decade old (so that the data was not yet
reliable enough for its inclusion in the CPI).

8. (SBU) Overall, he said, the current housing market in China
is still manageable for middle and high income households. Low
income households are also managing as they have access to
government housing programs whereby they can rent low-cost
homes. However, moderate income households - with incomes too
high to qualify for low-income housing but falling short of the
middle class -- are falling through the cracks. The IFC is
trying to push the government to address this problem, with a
focus primarily on incentivizing commercial developers to build
moderately priced housing for this market. To this end, Lai
believes the government should conditionally support developers
by providing lower priced land and government subsidies. In
addition, he emphasized the need for mortgage insurance, and
more broadly for capital market development in order to broaden
mortgage access.

Toward a "Respectable" Mid-Level Economy in 10-20 Years: China
Must Shift to Become a Knowledge - and Service-Based Economy

--------------------------------------------- -----------------

9. (SBU) China will remain a "poor country" for years to come,
and can expect to emerge as a "respectable mid-level" country
only in another 10-20 years, Lai said. Successful development
over this period will require a structural shift so that Chinese
companies' share of the intangible elements of economic output
increase significantly. China's share of the research and
development, services, and marketing remains low, he emphasized.
He stressed that the service sector accounts for only 30-40
percent of the economy at present, in contrast to the US at 75
percent, and Europe at 70 percent. In the coming years, China

CHENGDU 00000005 003.2 OF 003


needs to affect a shift to increase the service sector to at
least 60 percent.

10. (SBU) The necessary structural shifts are already happening
to some extent in places like the Pearl River Delta, Lai noted,
highlighting a transition there from industries requiring
low-tech labor, to those that are increasingly skills-based.
Citing historical shifts in other Asian economies such as South
Korea, he also foresaw Chinese companies increasingly setting up
factories overseas, utilizing local labor with Chinese
management. As the Chinese economy shifted to become more
knowledge-based, and as Chinese companies increased their
overseas presence, the constituency for IPR protection would
also expand, he believed.

"Terrible" Education System Is Main Impediment

--------------------------------------------- -

11. (SBU) However, Lai identified China's "terrible" educational
system as presenting a serious impediment toward achieving a
shift to a more knowledge-based economy. The current system
promotes copying and pasting over creative and independent
thought. Lai said that the system rewards students for thinking
"within a framework" in order to get the grade. He described
the normal process undertaken by students when writing as
essentially collecting sentences from various sources without
any original thinking. He compared the writing ability of a
typical Chinese Phd as paling in comparison to his "unskilled"
staff during his decade of work with the IFC in Africa.
BROWN

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