MNI INTERVIEW: Ex-PBOC Advisor Calls For Fiscal Expansion

     BEIJING(MNI) - China needs to boost public infrastructure investment to

keep economic growth at 6.5%-7% a year, and the People's Bank of China should

back up this more expansionary fiscal policy with rate cuts, a former senior

advisor to the People's Bank of China told MNI.

     "Expansionary fiscal policy combined with proper monetary policy is a

precondition to help establish a bottom for economic growth," said Yu Yongding,

a senior fellow of the CASS, China's top official think tank, and former member

of PBOC's monetary policy committee.

     The central government has ample room to increase spending and even expand

borrowing in excess of the targeted fiscal deficit ratio of less than 3% of

gross domestic product, he said, noting that China's fiscal position is still

relatively strong and the country has large state-owned net assets.

     Even though accounting for implicit government debt and instruments such as

infrastructure-backed special purpose local government bonds not counted in

headline fiscal calculations may push up China's budget deficit to 5% of GDP,

China can still afford a higher deficit, Yu said.

     A more expansionary fiscal policy, increasing the size of the government

bond markets, would also help the PBOC by allowing it more of an option to

manage interest rates by buying debt, he said,

     Easier monetary policy should also play its part in supporting the economy.

     "A rate cut is necessary to lower the price of government bonds and help

reduce companies' financing burden," Yu said.

     --DOMESTIC DEMAND

     Arguing for the country to shift the focus of its economy more to domestic

demand as global GDP slows, Yu said China's large trade surpluses with the U.S.

have led to disproportionately large holdings of U.S. dollar, which represent a

significant misallocation of resources.

     Beijing should allow its exchange rate more freedom to move in line with

market trends, and avoid wasting its foreign exchange reserves, standing at

USD3.1 trillion at the end of September, on shoring up the currency, Yu said.

     The PBOC reportedly spent about USD 1trillion of reserves in 2015-2016,

when the yuan fell sharply and approached 7 to the dollar. The level was finally

breached in August this year.

     "I have repeatedly stressed the importance of the liberalisation of the

yuan exchange rate. And we have seen no big depreciation even after the yuan

dropped below 7," he said.

     U.S Treasury data shows China reduced its holdings of U.S debt in five out

of the past six months, taking its total to USD1.11 trillion as of the end of

August, the lowest since May 2017. Meanwhile, according to the China State

Administration of Foreign Exchange, the PBOC had as of the end of September

added gold reserves in ten consecutive months.

     Management of forex reserves has to consider security, liquidity and

profitability, Yu said. "I think it is a normal operation based on the returns

of different assets, and so far, the return of forex reserve investment has been

high and stable."

     The yield on China's forex reserves averaged 3.68% from 2005 to 2014, the

latest data from SAFE showed.

     --FOREIGN DEBT

     While a weaker yuan would push up the price of foreign debt repayments,

China's capital controls should prevent outflows from causing significant

financial risks, Yu judged.

     The need for foreign borrowing even at a time when China's savings are high

is a result of a structural problem, he said, although he added that foreign

debt levels were still not very large.

     "We should consider where there is a problem with the economic mechanism,

which has caused a misdistribution of resources," Yu said.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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