Logan Wright, of Stone & McCarthy has been trying to count the amount of money likely to be sloshing through the system over the next few months and comes up with some very interesting numbers. In a note he sent me yesterday (“We’re going to need a bigger boat”) he points out that the next four months may be very trying times for PBoC money management.
First off, an awful lot of PBoC paper is maturing during this time.About RMB 1.5 trillion is coming due between December and March, with a peak of RMB 586 billion in January alone. This is, according to Wright, “the largest four-month volume of paper redemptions in the history of PBOC sterilization operations.”
In itself the fact that we are record levels doesn’t surprise me. With foreign currency inflows and concomitant reserve growth accelerating over the past three years, it is not surprising that every few months we hit a new record – whether we’re measuring industrial production, credit growth, the trade surplus, or, why not, maturing central bank bills. By the way yesterday we saw that the Purchasing Managers’ Index rose from 53.2 to 55.43 in November, suggesting that industrial production is going to surge. This is not surprising given recent high fixed asset investment levels. With surging industrial production will come, as I have argued many times before, a rising trade surplus and, along with it, more foreign currency inflows.This is a hard trap from which to escape.
But to get back to Wright’s piece, RMB 1.5 trillion of maturing bills in four months is a big number, about $50 billion a month on average, comparable with and even larger than the monthly increase in reserves. Basically the PBoC has not only to mop up an expected $30-40 billion of foreign currency inflows every month, a Herculean task as it is (October’s reserve increase was $21 billion, probably low because of transfers to the CIC, but it has averaged $39 billion a month in 2007), but it must add to the mop-up the maturing of a substantially larger amount of maturing central bank bills during the next four months.
But there’s more. Wright argues that the maturing of repurchase agreements will add another RMB 250 billion over the four months, bringing the total amount of money entering the system to nearly $60 billion a month, not counting the PBoC purchase of net foreign currency inflows, which could mean managing $80-100 billion a month of new liquidity. In addition the recent amount and structure of fiscal revenues will add to the liquidity far more than it normally does. Wright explains:
Fiscal revenue is sky-high this year, up from last year's total of 3.87 trillion yuan to an estimated 5 trillion yuan this year, according to a report from Yao Jingyuan, chief economist of the National Bureau of Statistics, cited in the Shanghai Securities News on November 26. The targeted revenue level was 4.4 trillion yuan. Fiscal deposits have continued to grow in the central bank throughout the year; as of the end of July, they had risen by 1.036 trillion yuan since the end of 2006. Usually, government departments spend their budgets toward the end of the year in order to justify higher budgets in the following year. Typically, in December, money flows rapidly out of government deposits at the central bank; last year, the month-on-month decline in December was 557 billion yuan.
This year, with revenues even higher, the outflow could be higher as well. A report from the State Information Center on November 12 warned about precisely that outcome, stating, "If we were to stick to the fiscal deficit target set at the beginning of the year, fourth quarter (government) spending would have to be very large to achieve that deficit, which could significantly boost aggregate demand in the economy." The report cited spending levels as high as one trillion yuan in the fourth quarter were possible, and warned against that level of spending.
Will the PBoC be able to sterilize this flood of money?Unless they are willing to see interest rates rise much higher, it is pretty unlikely, and the several spikes we have seen in pre-IPO repo rates (see my November 8 entry “Small banks getting squeezed by IPOs”) have made banks less willing than ever to tie up money in anything except the shortest maturities. This will make selling PBoC bills a very difficult task unless they are willing to pay up.
Remember, by the way, that high interest rates only increase the attractiveness of domestic markets to foreign money, and are likely to encourage even more speculative inflows into the country. Allowing rates to rise in order to accommodate a higher volume of sales may only increase the amount of paper that needs to be sold. PBoC money management is not easy.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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December, 2007
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