My Blog

January 30, 2008

What can the PBoC and the financial authorities do?  Last Thursday Premier Wen Jiabao told the State Council that 2008 was going to be an extremely difficult year – an extraordinary admission by some accounts and indicative of how much pressure he is under.  Rising inflation and energy shortages have been made worse by the huge snowstorm that has hit the country, severely damaged crops, and closed train lines just as Chinese families were gearing up for the all-important Spring Festival, driving food inflation before this all-important family holiday much higher.  Domestic overheating, which in the last few months has become a concern almost to rival rising inflation, had been met for much of last year with rising interest rates and minimum reserve requirements, but the much tougher policies enacted in the past three months have suddenly been thrown into question by worries that a slowdown in the US will lead to a sharp drop in export growth.  Rumors are flying about the possibility of a reversal of the tightening measures announced last October.

Should the authorities continue tightening or should they backtrack?  Some analysts are now arguing that they cannot continue tightening and should actually reverse policies.  There is a real risk, they claim, that the previous domestic tightening measures will cause investments to slow sharply just as a US economic slowdown kicks in and drives down Chinese export growth.  These were the twin pillars of the Chinese economy, and for both of them to decline sharply at the same time might be more than the economy could bear, although one bit of good news in this almost unbearable gloomy environment was released by the National Bureau of Statistics today.  It turns out that private consumption contributed 4.4 percentage points the China’s 2007 GDP growth (11.4%), making it for the first time the biggest single contributor to Chinese growth.  If investment and exports are going to decline, we may need healthy consumption growth to moderate the impact, although I wonder if consumption can hold up in an otherwise poor economic environment.

On the other hand overheating has been a serious problem for the Chinese economy and if 2008 were to experience the same breakneck growth as it did last year, the adjustment will almost certainly be more difficult.  If the US slowdown is not as great as some think it might be, or if its impact on Chinese exports is less than many worry, expansionary policies in China may set off one last, crazy bull run.

On the inflation front the news is even grimmer.  The rate of inflation will almost certainly rise in January. To above 7% from 6.5% in December and 6.9% in November, even in spite of downward pressure put on it by recent government measures to make holiday conditions as good as possible – selling off food reserves and freezing price increases.  That almost certainly means that there will be more inflationary pressure in March and thereafter as these measures are unwound.  It would be ironic if a series of policy makes suddenly came to a head because of something for which it would be very hard to blame the government – the collapse in the weather.

Meanwhile divergent interest rate policies in China and the US coupled with the rising RMB will almost certainly cause a continued increase in hot money inflows, and so reserve growth will remain excessively high and monetary expansion to continue unabated.  I am hearing that increasingly think-tank and financial authorities are convinced that inflation is a monetary problem, and not a one-off food problem, although I would caution that the kind of people I am likely to hear from are not necessarily a representative sample of the policy-making class.

I am increasingly certain that the only thing China can do is a one-off maxi-revaluation.  However the economic environment is a lot less friendly today than it was even a few months ago.  The only thing to do is to watch CPI inflation numbers and hope they come down, but I don’t think that is very likely.

Comments (6) for "Things have gotten grimmer i...

I am still convinced that food and energy issues are global and non-monetary-related problem. It is more to do the limited supply due to monopoly (OPEC) and regulation (i.e., EU ag policy). Regard to China, I saw some news (more local airport construction projects) yesterday. I believe at least some part of government began to use fiscal tool to increase spending and stimulate economy. It looks like a typical textbook example of employing both monetary and fiscal instruments as far as I can tell. By fatbrick - 1/29/2008 9:23 PM

Since there has been quite a bit of excess monetary expansion around the world, why can't rising food prices be both global and monetary? It is hard to argue that rising global food prices have to do with either monopoly control of production or EU regulations, especially since much of it comes from the US, Australia, Brazil, Argentina, etc, none of whom are countries we normally associate with OPEC or the EU. By Tim G. - 1/30/2008 11:41 AM

EU had a quota system for ag production to limit production. US and Brazil have biofuel problems, which are exaggerated by ag interest groups' lobbying efforts. Granted, there is possibility that all major countries had loose monetary policies and caused the increasing food prices. But back to a year ago, Chinea's pork shortage was obviously caused by 1) over supply in 2006 2) disease 3) increasing feeding costs thanking to higher corn price. The persistent high food prices definitely have spill over effect on the whole economy, given food is a necessity and accounts for a large part of daily household expense. More money inflow may exercabate the problem. However, monetary policy cannot correct it. Ag subsidy and tax policy are more helpful here. In the long run, China needs to find more arable lands and increase ag productivity. By fatbrick - 1/30/2008 12:37 PM

Here is where we disagree fatbrick. I think only monetary policy can fix this problem. I guess we can watch over the next three months to see if subsidies and tax policies actually bring inflation down or whether they continue to spread. I hope you are right, but I am still expecting speedier appreciation or the one-off maxi-reval once all other policies fail. By Michael Pettis - 1/30/2008 6:23 PM

Monetary policy can bring down industrial demand and some consumer demand. However, for staple food, higher interest rate does not make more food. Appreciating RMB might help imports, but it hurts exports then employment then disposal income of the poor. Temporary rebate for food import and penalty for food export will do some of the tricks and maintain employment. More subsidies have to be distribute, effectively. Maybe I missed it, I did not see a lot of coverage on subsidies and tax policies from foreign media. By fatbrick - 1/30/2008 9:21 PM

Fiscal policy is an important item on the agenda in China. For example, the a Vice Minister of Finance gave a speech about it. http://paper.cnstock.com/paper_new/html/2008-01/14/content_60602111.htm PBOC vice banker Yi Gang also spoke on the importance of fiscal policy. http://paper.cnstock.com/paper_new/html/2008-01/14/content_60602108.htm The Ministry of Finance has a plan to transferring wealth to the countryside that the State Council will look at. http://www.zqb.cn/html/2007-12/15/content_11155049.htm Much of the fiscal transfers could involve improving health care and stuff. Tax laws have been changed, too. The minimum tax level is being raised I think. By orgulous - 1/30/2008 11:16 PM