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US debt crisis leaves China three major difficulties

By Ye Xiaonan (People's Daily Overseas Edition)

13:32, August 11, 2011

The first-ever downgrade of the U.S. sovereign credit rating from the highest level of AAA has triggered a chain reaction across the world, with radical fluctuations in the financial market, stock market slumps and gold price surges.

Industry insiders said that China is facing many difficulties when dealing with the current financial storm, including possible shrinkage of China's foreign exchange assets, an impact on exports and higher imported inflationary pressure. China needs to take into account the difficulties and adopt countermeasures.

Fall in U.S. dollar-denominated asset values

The downgrade of the U.S. debt credit rating and falling U.S. debt value will first lead to shrinkage in China's foreign exchange assets.

Liu Yuhui, director at the Financial Research Lab of the Financial Institute under the Chinese Academy of Social Sciences, said that as about two-thirds of China's foreign exchange reserves are U.S. dollar-denominated and China is the largest creditor country of the United States, China's U.S. dollar-denominated asset values will likely drop.

There has been no intensive U.S. debt sell-off in the market, meaning that the impact of the crisis has been so far limited to the psychological expectations for the market, leading to the stock market slumps on Aug. 7. As various sides have sent out positive information helping stabilize the market, investors' sentiment has somewhat calmed down.

"The current largest holder of the U.S. debt is the Federal Reserve, followed by China, Japan and the United Kingdom. The political heads of the official institutions have relatively strong coordination capacities. In fact, no official institutions have recklessly cut their U.S. debt holdings, and major holders are continuing to increase their holdings. No debt markets in the world other than the U.S. debt market can meet the demand for the huge amount of increase in official foreign exchange reserves. Such a stable structure has eased the intensive sell-off pressure."

Affecting China's export and shipping negatively

Analysts said that since it is hard for the U.S. economy to rise again, China's import and export enterprises will probably face various difficult environments, such as persistently-weak overseas market demand, exchange rate appreciation and increasing foreign trade friction, in the next few years. China's export trade will also inevitably be affected.

Ma Jun, chief economist for the Greater China region of the Deutsche Bank, believes that the downgrade of the U.S. sovereign debt rating will negatively affect China's economy, especially China's export, shipping and bulk commodity industries.

Some insiders predict that the Unites States may require China to further open its markets and keep pressing China for RMB appreciation. In order to protect the domestic economy, the trade protectionism may rise in the United States, and the United States may adopt such measures as increasing taxes and setting trade barriers to control exports from China and suppress China's export enterprises.

Xu Zhenyu, a special analyst for the Securities and Futures Institute under the Beijing Technology and Business University, told reporters of the People’s Daily that the U.S. debt crisis is once again a warning to China that it must practically change its development mode and reduce its excessive dependence on exports.

"As of now, China is still using its former economic development mode. The economic growth is driven by investments, which lead to excessive outputs. Since China's domestic markets cannot consume so many products, China has to rely on exports objectively," Xu said. "It is not easy for China to change its economic development mode, but despite any difficulties, China must do it. China should allow a relative slowdown of its domestic economic growth so that certain space could be saved to alleviate the in-depth problems that have emerged during development."

China to face greater pressure from imported inflation

Industry insiders noted that a massive money-printing campaign provoked by the U.S. debt crisis will cause the U.S. dollar to continue to depreciate, which will push up prices of dollar-denominated bulk commodities, given that the U.S. dollar is the primary currency in global trade settlement. As a large importer of raw materials, China will face greater pressure from imported inflation.

Lian Ping, chief economist at the Bank of Communications, said that the U.S. debt crisis will put pressure on the mobility of capital, and the depreciation of the U.S. dollar will increase the prices of bulk commodities.

"The prices of bulk commodities are falling sharply due to market panic but will soon rebound and increase inflationary pressure," Lian said.

Xu believes that the U.S. debt crisis will further aggravate inflation in emerging economies because the U.S. Federal Reserve may implement a third round of quantitative easing monetary policy and increase its holdings of U.S. government debt in order to ensure stable long-term interest rates. In view of this, China needs to develop some countermeasures.

"The U.S. dollar is bound to continue to depreciate, and emerging economies will become the safe harbor for investors amid the turmoil in global financial markets. Given various factors, China will suffer more severe imported inflation," Xu said.

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