China: Moving from or Clinging to Export Reliance?

We have, dear friends, reached the end of another year. Still, there is interesting news that suggest the Chinese are already thinking about 2011 while we're still celebrating the arrival of a new year (Chinese new year is still on February 3). The changes identified below seemingly indicate contrasting pressures on the PRC leadership.

First, the central government is demanding a greater share of dividend payouts from state-owned enterprises. Given the astounding rates of investment in China, I certainly believe this is a welcome development. Aside from reducing the potential for overinvestment, the hope here is that more state funds emanating from these SOEs will be allocated to spending on social safety nets which can encourage the emergence of a Chinese consumer culture:

Currently, 99 central government-backed firms are required to pay 5% of their profits as dividends, and 18 companies pay 10%. Another 34 centrally owned companies pay nothing. Under the new rules, 15 companies, including China's major energy and telecommunications companies, will have to pay 15% of profits in dividends. Another 78 companies in sectors including transportation and metals, will pay 10%, and 33 companies will pay 5%. Two companies that manage the government's grain and cotton reserves will continue to be exempt.

The new ratios are still far below the 33% average dividend that state enterprises pay on average in other countries, according to World Bank research. The World Bank and the International Monetary Fund have been among the most ardent advocates of an overhaul of the way China handles state firms' earnings, arguing that using the funds for costs like expanded health care would help lower China's astronomical savings rate and reduce its trade surplus.

Such arguments have come from within the government, too. Zhou Tianyong, a vice director of the research bureau at the Communist Party's Central Party School, recently suggested the government use the dividends from state firms to replenish China's national social security fund. Mr. Zhou, the central bank adviser, said the government should consult the public on how the dividend income should be spent.

It's good, encouraging stuff. On the other hand, the Chinese government is also implementing a measure that encourages exporters to keep more of their money offshore. Instead of having to repatriate overseas earnings ASAP (and strengthen the yuan with regular sales of foreign currency), the new ruling will allow Chinese firms more discretion in doing so. I may also encourage more Chinese firms to think about investing abroad--not a bad idea as a diversification play:

China said Friday it will allow the country's exporters to park their revenue overseas, expanding a trial program that marks a significant loosening of Beijing's currency controls and could reduce pressure on the yuan to appreciate. Under the new rules, which will take effect Saturday, qualified Chinese exporters will be free to decide on the length of time they want to keep their income offshore and when to repatriate the funds to China, the State Administration of Foreign Exchange, said in a statement.

Previously, Chinese exporters were required to repatriate their foreign currency earnings and exchange them for yuan under the so-called surrender requirement. But the influx of foreign exchange caused problems for monetary authorities, contributing to inflation pressures and putting pressure on the currency to appreciate.

"The direction is clear. The authorities want less foreign exchange to come in, so they are giving exporters the right to keep it abroad," said UBS economist Wang Tao. The move, which is modeled on a small pilot project that started Oct. 1, will also help Chinese companies conduct cross-border financing and support their overseas expansion, the foreign-exchange regulator said.

Relaxing the surrender requirement could help resolve several problems for Beijing. If firms aren't forced to repatriate their foreign earnings, it could reduce demand for the local currency, thus reducing pressure on the yuan to appreciate. The change could also reduce inflation pressures, and slow the buildup of foreign-exchange reserves. China's central bank, the People's Bank of China, bought up the foreign exchange under the surrender requirement, which left it with an ever-growing stash of foreign currency that it recycled into foreign government bonds and other investments.

Why yes, we do live in interesting times.