My Blog

April 21, 2008

What is 2008 CPI inflation for China likely to be?  Merrill says in an April 16 research report that they except it to be 6.9%, and most other bank researchers say it will fall between 6% and 7%.

Are these numbers plausible?  For the first three months of the year, inflation has been running at an average month-on-month rate of nearly 1.3%.  This is the equivalent of 12.9% on an annualized basis – i.e. if the average inflation rate for the first three months remained the same for the rest of the year, inflation for the year would be 12.9%.  If we say we expect that inflation for the full year will come in under 7.0%, we are also automatically implying that the average monthly inflation from April to December will be less than 0.4%, or less than 5.1% on an annualized basis.  That is a pretty steep drop.

We can extend these projections a little further.  If we assume that month-on-month inflation declines from 1.3% for the first three months to 1.0% in April, we would need average monthly inflation from May to December to be less than 0.3%, or less than 4.2% on an annualized basis.  Finally if we assume that month-on-month inflation for May also turns out to be 1.0%, we would need average monthly inflation from June to December to be less than 0.2%, or less than 3.0% on an annualized basis.

I can play around a bit more with these numbers to make more generous assumptions.  Let’s assume that inflation for April and May come down sharply from the 1.3% it has averaged so far this year.  Specifically let us assume that in April monthly inflation turns out to be half of the average so far, or 0.6% (for an annualized 7.8%) and then in May we decline to a level equal to the monthly average for the whole year (assuming inflation for the year is 7%), also 0.6%.  In this case we would need for average monthly inflation from June to December to be less than 0.3%, or less than 3.7% on an annualized basis.

No matter how you look at it, even if we make relative generous guesses about declines in April and May inflation, to get inflation for all of 2008 to come in under 7% we are going to need a very sudden and sharp decline in the inflation rate.  This is of course possible, but I think it is going to be hard for CPI inflation to start the year at nearly 13% nonetheless to finish the second half of the year at well under 4%.  I also think it would be inconsistent with the kinds of GDP growth rates that everyone expects.  Such a dramatic decline would almost certainly come with a very sharp economic slowdown, right?  I am having trouble accepting the consistency of inflation and GDP projections.

My own guess is that by May year-on-year inflation will exceed 10%, and that thereafter it will be very hard to bring the inflation level down much below that number.  This may be the most extreme view out there for now, but within a month or two I suspect that quite a few people will be projecting 10% inflation for 2008.  The key is what happens to non-food inflation.  So far it remains low but has been accelerating steadily all year.

On a separate note the stock market traded up today, for the first time in nearly a week.  The real interesting thing is how it traded up.  Last night the China Securities Regulatory Commission said that shareholders selling more than 1 percent of previously locked-up shares within a month must do so in single block trades.  They could not just sell them piecemeal into the market (although if they sell less than 1% a month they can do so).

The move was transparently intended to prop up the market, which has all but collapsed in recent weeks – and has lost half its value since its November peak.  One of the things apparently weighing on the minds of investors is the possibility of a deluge of previously non-traded shares coming to market.  By presumably making it more difficult to dump shares, this move was supposed to reassure the market and signal the government’s concern.

Leaving aside the fact that this move really doesn’t do much as far as I can see, the important thing was the signaling effect, and sure enough the market responded exactly as expected.  Within minutes of the opening the market was up around 6%.  Very shortly after its stunning open, the selling started and it had given back much of its upward move by the midday break.  Selling continued through the afternoon and by the close of day the market was up by less than three-quarters of one percent.

Needless to say this is pretty bad news for the long-term development of the markets.  The whole thing was nothing more than a very naked attempt by the government to intervene in the market and as far as I can tell there is not a single fund manger or analyst in China who does not see it that way – every press report in the morning had fund managers saying explicitly that this was intended to shore up the market, even while a few of them warned that it would have no real impact..  

What’s the message?  The same as always.  The local stock markets have nothing to do with fundamentals and everything to do with current government intentions.  This constant changing of the rules of the game to suit the current political mood is not the right way to create a well-functioning capital market that allocates capital efficiently.  This fairly blatant manipulation only ensures that the market will remain undeveloped, and a haven for insiders and speculators, for longer.

The only thing new, as far as I can see, is how rapidly the credibility of government intervention in the stock markets is eroding.  The market soared at first by an astonishing amount not because of the real impact of the new measure, but simply because of what it signaled.  It then gave nearly everything back within hours.

This was hardly unexpected.  Serial attempts by governments to manipulate markets always results in an erosion of the government’s ability to do so.

Comments (5) for "Inflation projections and ma...

A monthly 1,3% gives an annual of even 16,8%. By Stefan, Tallinn - 4/21/2008 5:41 AM

What about the price of oil/fuel ? W/ oil near $120, a normal diesel/gasoline price would be at least $125/bb wholesale.or $3/ltr (or gallon, close enough for now), and would be about $3.25 at the retail level, with no taxes. What the retail price in China. There doesn't seem to be any good sources of info, would be nice to know. I here that its fixed to where its about $75/bbl for crude as a break even price for the refiners. That implies a $40/bbl, that implies a $1/lts discount at the pump. So if one were to plug that into the inflation numbers, the real inflation would be out of hand, esp as other prices adjust upward to compensate for the higher fuel cost. I imagine similar numbers for coal,NG,electricity. Someone is losing a fortune in China. Just the discount on the retail price of oil products is in the range of $150B/yr. It looks like the governement is forcing the big oil companies to eat it. They produce 1/2 the oil at I imagine about $40/bbl or maybe less, and they import 1/2 at $120, that means the average is about $80 - close to the actual implied basis for the retail price. So basically, the whole complex production/refining/retail complex should be close to zero profits if you could get all the data. The big state oil firms are showing some profits but I imagine there are big losses somewhere else. Sooner or later, the government is going to cry uncle and raise prices. I imagine at some point we are going to see a big spike in product prices and it would be better if the government adjusted now rather than later. By SuperDiesel - 4/21/2008 11:12 AM

Stefan, you are absolutely right and I apologize for the mistake -- this is what comes from playing so much with the numbers that I inadvertently transposed them. Nominal quarterly inflation is 3.1%, which annualizes to 12.9%. Monthly inflation for the first three months does not average 1.3%, it averages just over 1.0%. I believe the rest of the numbers are correct. SuperDiesel, I don't drive a car so I don't have direct experience with gasoline prices at the pump, but my understanding is that gasoline is sold at an implicit price of around $45 per barrel of crude. That means that the government and the oil companies are effectively subsidizing oil prices by over 50%. I think of this as a conversion of CPI inflation into higher taxes and lower profits (which, since oil companies are wholly owned by the state, amounts to the same thing). Without this subsidy prices would certainly be higher and inflation would also be higher. By Michael Pettis - 4/21/2008 2:04 PM

I don't really see it as that bad that the government is trying to influence the overall level of the stock market, because in that situation what gets affected is the amount of capital in the markets versus capital in other financial assets, and that allocation between stocks and other financial instruments is not particularly rational. What would be a much larger problem is if the government started favoring one company or industry over another, and none of the recent initiatives do that. If government policy causes more or less money to go into the stock market, but once that money is in the market it gets split up among the companies in the market in some semi-rational way, I don't see this as being bad for the economy. By Twofish - 4/21/2008 7:11 PM

Super diesel: FYI, Gas in china costs 5.34 yuan (76 cents) a litre or 20.5 yuan ($2.90) a gallon. State oil companies are barred from passing on rising crude costs to consumers, and are instead covering their losses out of profits from their drilling units. The resultant market distortion caused by the government's decision to vastly underprice the cost of gasoline has resulted in luxury cars and SUV's being the fastest growing vehicle sales in China. Curious how China's wealthiest citizens reap the greatest benefit from a policy ostensibly designed to help farmers and "the poor". Sales of these high end, costlier vehicles are surging at a rate of 40-45% vs. 15-20% for the overall car market. Mercedes alone reports that sales of its R-class minivans jumped 110% while those of M, G, and GL SUV's have doubled.....fyi, China now accounts for one third of Mercedes global sales. Tim Dunne, J.D. Power's director of Asia-Pacific market intelligence was quoted at the Beijing Auto Show as saying, "Chinese buyers typically like bigger cars and they have the resources to go for them." Subsidized conspicuous consumption of vehicles with big engines and more horsepower will only serve to add to China's 12.3% yr-yr increase in oil imports, not to mention environmental pollution. By kevinfischer2002 - 4/22/2008 7:25 AM