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BIZCHINA / Backgrounder

Currency swap

Updated: 2006-10-18 10:40

A currency swap means an arrangement in which two parties exchange
specific amounts of differen

BIZCHINA / Comments & Analysis - Overseas

China needs to diversify economic growth model

Updated: 2006-11-23 17:16

China had made striking progress in the last 27 years, but while its
development model remains focused on fixed investment and export, it will
be difficult for the country to go develop further, said Stephen Roach,
Morgan Stanley's chief economist in a speech at CEIBS Executive Forum.

Mr. Roach recommended that in the next three to five years, the
transformation in China would be to move out of exports and investment,
and much more into the neglected sector-private consumption. That does
not mean the exports and investment won't grow, for China still needs
investment for urbanization and industrialization, and exports to create
job opportunities and boost output. However, what China needs the most is
a more balanced and diversified economic growth model.

China is probing into the necessity of rebalancing economic development,
said Mr. Roach. A key issue is the gap between the country's urban and
rural areas. Farmers need to earn a higher income and consume more, which
is not presently possible. Narrowing the gap will be difficult and it
will take time, and it is likely that the consumption capacity of people
in urban and rural areas will never be absolutely identical.

Mr Roach referred to a survey that shows that Chinese households have
become increasingly dissatisfied with the level of saving since 1997. One
might think it unusual because it is well know that Chinese families have
the highest savings rate in the world. But according to the survey, they
are not happy with it. The reason for this is economic insecurity, which
has caused people to save as a precautionary measure. Chinese leaders
have wisely made boosting domestic consumption and, in particular,
establishing a national security plan a focus of their 11th Five Year

This by no means indicates that the Chinese consumers are about to emerge
as the world's economic engine as their starting point is very low. The
gap between the personal consumption of the US and that of China is too
huge to be filled instantly. The two figures in 2005 were 9 trillion for
the US and 1 trillion for China respectively. It means that for every one
percentage point the American consumers weakens, the Chinese consumers
will have to grow 9% point to make up the gap. That is not going to
happen overnight.

Conversely in the US, something needs to be done to curb the extravagant
spending of US consumers as their savings rate is the lowest in the
world. Mr. Roach concluded that if American customers save more and
Chinese customers save less, the world would be more economically stable.

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t currencies initially, and a series of
interest payments on the initial cash flows are exchanged.

Often, one party will pay a fixed interest rate, while another will pay a
floating exchange rate (though there may also be fixed-fixed and
floating-floating arrangements). At the maturity of the swap, the
principal amounts are exchanged back. Unlike an interest rate swap, the
principal and interest are both exchanged in full in a currency swap.

An interest rate swap is a contract to exchange cash flow streams that
might be associated with some fixed income obligations, say swapping the
cash flows of a fixed rate loan for those of a floating rate loan. A
currency swap is exactly the same thing except, with an interest rate
swap, the cash flow streams are in the same currency. With a currency
swap, they are in different currencies.

That difference has a practical consequence. With an interest rate swap,
cash flows occurring on concurrent dates are netted. With a currency
swap, the cash flows are in different currencies, so they can't net. Full
principal and interest payments are exchanged without any form of netting.

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