UPDATE 2-Ahead of G20, China urges caution in Fed policy tapering

Tue Aug 27, 2013 5:35am EDT

By Kevin Yao

BEIJING Aug 27 (Reuters) - The U.S. Federal Reserve must consider when and how fast it unwinds its economic stimulus to avoid harming emerging markets, although the impact on China could be more limited compared with some other countries, senior Chinese officials said on Tuesday.

The warning by China's Vice Finance Minister Zhu Guangyao and central bank Vice Governor Yi Gang came as economies from Brazil to Indonesia struggle to cope with capital flight as U.S. interest rates rise ahead of an expected tapering off in the Fed's bond buying programme that unleashed liquidity across the world.

"The U.S. economy is showing some positive signs and is recovering gradually and we welcome this," Zhu told a briefing ahead of G20 leaders' summit in Russia next week.

"But the United States - the main currency issuing country - must consider the spill-over effect of its monetary policy, especially the opportunity and rhythm of its exit from the ultra-loose monetary policy," Zhu said.

Apart from being a leading emerging market, China has a major stake in the direction of Fed policy as one of the biggest creditors to the United States. A substantial portion of its foreign exchange reserves - the world's biggest by far at some $3.5 trillion - are invested in U.S. government, agency and corporate debt.

Financial markets are fretting that the U.S. Fed might decide to reduce its monthly bond buying when it meets on Sept 17 and 18. Fed Chairman Ben Bernanke said in June the bond buying programme could be halted by the middle of 2014.

The prospects of the Fed reining in its stimulus comes as China's economic growth slows down to its weakest pace in two decades, partly as the government tries to reduce its reliance on exports in favour of domestic consumption.

Zhu said China faced a severe economic environment at home and abroad, but it would keep economic policies stable.

China will refrain from providing fresh stimulus and he predicted the economy was on track to grow around 7.5 percent this year - in line with the government's target.

The government will instead quicken structural adjustments, including efforts to reduce with factory overcapacity, he said.

Speaking at the briefing ahead of the G20 meeting in St Petersburg on Sept 5 and 6, Vice Governor Yi Gang said how nations might cope as developed economies tighten monetary policy will be a focus of the G20 meeting.

"On monetary policy, the focal point (of G20) will be on how to minimise the external impact when major developed countries exit or gradually exit quantitative easing, especially causing volatile capital flows in emerging markets and putting pressures on emerging-market currencies," Yi said.

"The impact on China will not be obvious compared to other emerging economies - the yuan will be stable and monetary policy will be stable," he said.

Analysts said Yi was probably referring to China's capital controls and its foreign currency reserves, which provide cushions against economic shocks.

"Not only China has capital controls, it also has piles of FX reserves and current account surplus, these are the advantages for China to weather the Fed tapering," said Minggao Shen, China economist at Citigroup in Hong Kong.

China keeps a tight grip on capital account transactions, but there are many loopholes, especially through trade flows, analysts say. So China's economy could face some pressure from capital outflows, they say.

A $100 billion foreign-currency fund being discussed by countries that make up the BRICS grouping of Brazil, Russia, India, China and South Africa will be set up in the foreseeable future, Yi said, adding that China would provide "a big share" of the funds but he did not give details.

"It will not exceed 50 percent," he said.

The BRICS' leaders have agreed to set up the fund to help ward off currency crises. It is expected to be formally launched at a BRICS summit in Brazil next year.

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