My Blog

December 17, 2007

Yesterday the State-owned Assets Supervision and Administration Commission (SASAC) announced they would require dividend payments from after-tax earnings for state owned enterprises.  Although commercial-bank lending constraints seem to be partially working, there has been no real reduction in fixed asset investment in China as of yet (the November reduction seems to have been more of a statistical effect).  This may be because informal and illegal banks, leasing companies, and direct investment have expanded by more than enough to take up the lending slack, and it seems pretty clear that large amounts of retained earnings are being plowed back into investment even in cases where the economic rationale for doing so is dubious.

To address the latter, and to reduce the amount of cash available for re-investment, SASAC is requiring state-owned companies to pay a share of their profits to the government in the form of a dividend.  Just over three-quarters of the 151 firms administered by SASAC will pay dividends equal to between 5% and 10% of after-tax profits.

I am not sure this is enough to make much of a difference.  According to today’s South China Morning Post “Two finance ministry officials reportedly said in June that the maximum payout ratio would be 20 per cent. They said some 60 billion yuan could be raised if an average 10 per cent payout ratio was applied.”  Transferring less than $8 billion from corporate retained earnings to the government won’t make much of a dent on investment, which exceeds $1 trillion annually, and anyway the transfer will reduce the government deficit and, along with it, government borrowing.  In that case it might free up as much new money in the bond markets as it withdraws from retained earnings.  Still, given the concerns I have about a sudden jump in contingent liabilities from the banking system if there is a sharp adjustment in the Chinese economy, I am glad to see anything that reduces government debt.

Of course there are also more rumors running around about additional PBoC actions and finger-wagging to slow the economy.  The PBoC is clearly considering more minimum reserve and interest rate hikes, but now there is talk of “differentiated” reserve requirements – that is different requirements for the larger banks, who take in more deposits as a share of funding than the smaller banks, or higher reserve requirements for new deposits.  It will be very interesting to see if these new measures make taking deposits less profitable for banks and so create incentives for them to discourage additional deposit growth.  This might have the effect of simply channeling monetary expansion into areas where the PBoC has a more difficult time controlling and regulating.  By the way deposits grew rapidly in November.

The PBoC actions are definitely hurting property speculation. Gerry Xu Feng, the chief officer of the research department at Midland China in Shenzhen, said, according to the SCMP, that about 10% of the 30,000 estate agents in Shenzhen had quit their jobs.  I guess it is getting harder to make a living churning property.  Real estate prices are reportedly lower in the main cities, and property developers have been among the worst performers in the domestic stock markets. 

We all want to see a slowdown in property speculation, of course, but many people, including me, wonder about exactly how much exposure the banks have to the property sector (direct exposure is high enough, but there is anecdotal evidence that indirect and hidden exposure is also extremely high).  The danger of all these attempts to slow property speculation and other effects of excess monetary expansion may make China like the bather, in an analogy attributed to Milton Friedman, who gets scalded after turning the hot water all the way up in a chilly shower.  Because of the lags and the difficulty of transmitting monetary policy into the non-coastal provinces (where a very interesting study I read last month – I can’t remember the citation – suggests that there are problems with the transmission mechanism for PBoC monetary policy), the belated attempt to get out of the freezing water of property speculation may lead to the scalding water of a surge in real-estate-related non-performing loans.  There really are no easy or obvious policies for the PBoC to pursue as long as their currency regime imports such massive amounts of liquidity.

Comments (5) for "Don’t turn the shower faucet...

I guess this surely sounds un-economic. Banks have more underperformed bad loans in real estate. Writing off those potential bad loans in an economically booming time means taking out liquidity from economy plus cleaning banking system. Real estate speculation then declines, which means the housing price drops. Most people will love this and social stability can be improved. The government will laugh in the dream if this can be achieved. The party bearing the loss is speculators and developers. Hey, they are already super-rich, this does not hurt that much. It seems to me that the scenario you described is just ideal for China right now. By fatbrick - 12/17/2007 10:19 PM

Mike, East Morning Daily reported the dividend rates on Sept. 20: this is one of those many cases of recycling the news to get additional effect because people didn't pay attn to it the first time. The economists who have watched this most closely are disappointed. The low rate could be ratcheted up in future though. On bank lending in total FAI the story is even sadder -- done to about 17% of FAI presently from 29% at start of 2004. Just too much cash at corporates, foremost SOEs. By Dan Rosen - 12/18/2007 1:33 AM

I suppose the reasons that economic actors do not react/respond to gov. economic policies the way policy makers prefer are: (i) the policies were historically ineffectual and therefore ignored; (ii) the intended effects were materially weakened during the transmission process, and (iii) the actors do not understand or appreciate the message due to "ignorance" resulted from lack of experience. Time to increase the voltage or turn-on the hot water! In some way, wouldn't a moderate shock therapy be just the right way to sear some senses into the masses? After all, from South Sea speculation, to Tulip rush, to dotcom bust, to the most recent sub-prime debacle, each shock instilled a bit of sense and added knowledge to the existing financial system in the OECD countries... By zh - 12/18/2007 3:02 PM

I pretty much agree with that. Or put the other way: is there any chance of acheiving reasonable investor behavior WITHOUT a greater degree of pain and shock when investors get their experience the hard way. By Dan Rosen - 12/18/2007 10:27 PM

I am a little pessimistic about the ability to "learn" without shocks. Traders often say that the only way you can learn how to trade is when you lose money. By Michael Pettis - 12/19/2007 1:19 PM