×

China to Cut 2007 Budget Deficit, Considers Widening Yuan Band

China plans to cut its 2007 budget deficit to 245 billion yuan, or 1.1% of gross domestic product, the finance ministry will project in a report to parliament on Monday.

That compares with a deficit in 2006 of 275 billion yuan ($35.5 billion), or 1.3% of GDP, which was well below the government's initial target of 295 billion yuan. The report projects national fiscal revenue in 2007 of 4.4 trillion yuan, 13.8% more than in 2006, with total spending of 4.65 trillion yuan, an increase of 15.7%.

The central government will allocate 130.4 billion yuan for investments this year, 15 billion yuan more than last year. Of that sum, 50 billion yuan will be funded by the issuance of treasury
bonds -- down from 60 billion in 2006.

The government has been gradually reducing the volume of long-term bonds, which it launched to prop up the economy in the wake of the 1997/98 Asian financial crisis. The finance ministry also proposes a ceiling for the outstanding stock of treasury debt in 2007 of 3.787 trillion yuan, 248.4 billion yuan more than in 2006.

The report, excerpts of which were seen by Reuters, says China will set up a contingency fund of 50 billion yuan. "The central budget stabilization fund is a special fund to offset the gap
between income and expenditure when national revenues fall short of the budget," the ministry says.

Beijing will also pave the way for state firms to start paying dividends by launching, on a pilot basis, what the report calls a "budgetary system for the operation of state capital".

Analysts say the scheme is the first step towards requiring large state-owned enterprises to pay dividends to the central government depending on their financial health. All centrally controlled companies and tobacco firms will be involved in the new scheme this year.

China's 161 centrally controlled state-owned enterprises (SOEs), which earned a combined profit of 1.1 trillion yuan in 2006, have been allowed since 1994 to retain their earnings to fund expansion. Getting SOEs to pay dividends is aimed at forcing big companies to think twice before investing blindly and at raising cash for the government to pay for infrastructure and public services.

China To Widen Yuan's Trading Band

Separately, China will widen the yuan's daily trading range but has no timetable for doing so, central bank governor Zhou Xiaochuan said on Monday.

The People's Bank of China (PBOC) still had room to manage the currency within its current bands, which would be eventually widened depending on the market, Zhou said. "If market conditions show that the current band is not sufficient, then we could consider whether it is time to widen the band," Zhou said. The yuan may rise or fall by 0.3% a day against the dollar from a morning midpoint set by the PBOC.

The central bank set the yuan's rate on Monday at 7.7403 against dollar, the highest level since China abandoned a dollar peg in July 2005, revalued the currency by 2.1% and set it free to float within managed bands.

The yuan has now gained a further 4.75%, but that is not enough to satisfy U.S. critics, who say China's record $177.47 billion trade surplus last year proves that Beijing unfairly holds down the currency to give its exporters an advantage in global markets.

With protectionist sentiment rising in the U.S. Congress, the issue is sure to be aired when Treasury Secretary Henry Paulson makes a brief visit to Beijing on Wednesday.

Reserves Shift?

Zhou, choosing his words carefully, dropped a hint that China has been diversifying its $1.07 trillion stockpile of reserves, which bankers assume are invested largely in dollar assets.

Asked whether China was buying more Asian currencies and the euro, Zhou reiterated China's long-standing policy of managing the reserves with a view to safety, liquidity and returns. "If you just imagine, you can know what should be done about that," he said. "But if I say here what should be done, it could easily have an impact on the markets. And it wouldn't be appropriate to trigger unnecessary fluctuations in the market."

Zhou described the current level of official interest rates as appropriate following two increases last year to cool the economy and keep credit growth in check. "But I'm not saying I'm ruling out the possibility of another interest rate adjustment, because a central bank will never rule out the possibility of using a monetary instrument," he said.

Speculation has been rife that another increase could be needed if inflation accelerates in order to keep after-tax bank deposit rates positive in real terms.

One-year certificate of deposits yield 2.52% before tax compared with annual inflation in January of 2.2%. Zhou acknowledged that price pressures would be a key factor in shaping the interest rate outlook and described the current inflation rate as a little high.

Before falling back to 2.2% in January from a year earlier, consumer prices had risen 2.8% in December. "From the end of last year until now, it has gone a little higher and it will require continued monitoring," Zhou said.

He said the PBOC also needed to take growth and conditions in the banking system into account in setting interest rates. Turning to an order issued on Friday to domestic and foreign banks to sharply reduce their short-term foreign borrowings, Zhou said the curb would not
impair foreign banks' ability to do business in China.

A foreign banker told Reuters that this could be the case because foreign banks have few retail deposits and are limited in how much they can borrow from the domestic money markets.