My Blog

February 28, 2008

The State Information Center, a think tank affiliated with the National Development and Reform Commission, the country's top planning agency, has weighed into the policy debate by recommending that the government maintain its tightening monetary policy.  It said that the government might consider relaxing the measures over the short term because of last month’s horrific weather crisis, whose economic impact nonetheless is likely to be “limited and temporary”, but that ultimately policymakers should continue with prudent fiscal policy and tight monetary policy.  In the same report they predicted that CPI inflation for the first quarter would be 6.9%

I have already pointed out many times that I don’t believe monetary policy can be tight until the currency regime is fixed and capital inflows sharply reduced, which is not what the authorities are contemplating.  I also think 6.9% for the quarter is overly optimistic, although perhaps announcing this estimate as their expectation may just be part of the campaign against rising inflationary expectations (although if this is the case it does nothing to help their credibility). 

Why overly optimistic?  I am already hearing anecdotal evidence and rumors that February CPI inflation will be higher, maybe even substantially higher, than January’s 7.1%.  Let us assume that it comes in at 7.0%.  We would need March to come in at 6.5% to bring inflation for the month to 6.9% (if February is 7.5% or 8.0%, March would have to be 6.1% or 5.6%).  Since even the one-off-food-constraint camp believes that it might not be until summer or early fall that food production gets back on line, I don’t think we can expect March CPI numbers to drop so quickly, although they are priced off a higher base.

In addition, a friend sent me this today from MarketWatch:

Guangdong, China's richest province, said it plans to raise minimum wages by as much as 18% in some cities starting April 1. The decision followed similar actions in other areas, notably the major cities of Shanghai and Beijing. Tibet, an autonomous region administered by China's central government, raised minimum wages by nearly 50% at the beginning of this year. The wage increases, aimed at relieving food and other price pressures, could instead fuel inflation, analysts said. Higher wages are also likely to raise prices of U.S. imports from China, and possibly reduce China's attraction as the world's manufacturing center…

Guangdong will increase the province's minimum wages by an average 13% on April 1, the province's labor bureau said in a news release last week. The southern China province produces about 13% of China's economic output, the most among the country's 32 provinces.  Minimum wages in the capital city Guangzhou will rise to 860 yuan ($120) per month from 780 yuan, an increase of 10%. Wages of other cities in the province will also get a boost, with those in some inland cities up nearly 18%.

China's other provinces took similar actions earlier this year. Starting Jan. 1, four provinces hiked their average minimum wages by more than 20%, with the increase in Tibet topping the list, according to data collected by Citigroup. Five other provinces increased average wage caps by more than 10%.  Beijing and Shanghai, China's two biggest cities, last year raised their minimum wages to 730 yuan and 840 yuan respectively, in the face of rising consumer prices.  Average minimum wages in China have risen 15% in 2007, Citigroup said in a report, and 21% in 2008 based on available data.

If minimum wages are rising, driven by rising food prices, it seems hard to imagine that these increases won’t be priced into factory production.  Some of these wage increases are after the first quarter, so they will not contribute to inflation until much later, but several cities and provinces seemed to have raised the minimum wage early this year or late last year, and I guess we should start seeing the price effect now and into the near future.

In line with the announcement by the State Information Center, Han Yongwen, secretary general of the NDRC, is reported to have said in a conference in Suzhou yesterday that China faces “relatively high” inflationary pressure.  From what I gather other senior officials at the conference made similar noises about the need for vigilance, with one of them, Ma Delun, vice governor of the People's Bank of China, adding that China is “confident” that it will be able to tame inflation.

In the past few weeks there have been a whole series of statements on inflation worries and the need to maintain vigilance.  I am not sure how to interpret this.  On the one hand it may be evidence that the monetary alarmists have once again regained the upper hand in the policy debate.  On the other it may be because they are worriedly signaling to the NPC, which will be held next week and which will anoint the new senior leadership, including provincial and municipal leaders who traditionally like to begin their time in office by splurging on new investments, that this is not the time to go wild on new projects.

One group of players that might welcome a little inflation is the banking sector.  The good news is that last year’s profits have not been reported yet but are expected to surge.  According to an article in the Financial Times, analysts are expecting pre-tax profits to be up 83% in 2007 over 2006 (the 2007 estimate for pre-tax profits is for RMB 610 billion).  For four of the big five (the exception is ABC), ROA went up from 0.88% to 1.11%, a healthy improvement. 

On the other hand there is rising concern about real estate loans and declining real estate prices.  Yesterday the CBRC’s vice-chairman Jiang Dingzhi warned bank executives on the CBRC website of the risks of lending to real-estate developers, highly polluting or energy-intensive firms, and other problem sectors, ordering them to step up controls to prevent a rebound in bad loans.  According to today’s South China Morning Post:

More than one quarter of the new loans extended by domestic banks in Shanghai last year went to real estate, and by the end of last year the sector accounted for about 32 per cent of their outstanding loans, the 21st Century Herald reported on Thursday. The National Audit Office issued a separate warning that banks were lending too much to finance road construction - their exposure was 800 billion yuan at the end of 2005.  Bad management of some roads and insufficient toll collections meant many banks were finding it hard to recoup their loans, state media said.

I have heard it said, often enough that I believe it, that a lot of real estate lending is effectively hidden on the banks’ balance sheets and is not classified as such.  Banking exposure to real estate prices is much greater than the already high exposure levels reported.  As I mentioned in an earlier post, the NPL ratio rose slightly during the last quarter of 2007.  It was only a small increase in a year in which the ratio declined overall, but it occurred during a period rapid economic growth, slowing loan growth, and ample liquidity.

Comments (5) for "More warnings on inflation v...

Minimum wage in Guangzhou and Shanghai 860yuan, minimum wage in Beijing 730yuan? Well, this wage floor is so low that there will be little impacts on final goods. Regarding real estate bubble, it is better to let it burst now than later. If it could really bring down the housing price, everyone will happy. Most people will be glad to be able to afford their own houses. Government will happy since it is political popular. Even banks will have some relief. There are so many people still living in a rent apartment. Urbanization means that there is a much bigger customer base out there than the current housing inventory. If the house price declines, new loan growth will help them dilute the old bad loan problems. By fatbrick - 2/27/2008 10:05 PM

What with the rising costs of doing business like the minimum wage and the labor shortage in China might we not be seeing an illegal immigration problem in China? Maybe workers from places like Cambodia, Burma, or North Korea might start flooding into the Pearl River Delta or Dalian. By orgulous - 2/27/2008 11:54 PM

Good point, Fatbrick. An earlier rather than a later break in the housing bubble is probably in China's best interest, although whenever it happens it will not be comfortable. Sometimes what can be a crisis in the short term will actually help to address long-term imbalances. In fact one view of crises is that they represent necessary -- although sometimes violent -- adjustments to previous imbalances. For example I have written earlier about how the terrible 1797-98 crisis in the US forced it to turn away from exports as the engine of growth towards its own internal development. The risk of course is that a short-term adjustment gets out of control because of its impact, in this particular case, on the banking sector. The collapse of the Japanese real estate bubble was necessary for Japan own housing process, but becasue of the damage it did to the banking sector and, perhaps, because of the rigid and poorly thought-out way in which the authorities responded, it did leave the country with a "lost decade" of economic growth. The interesting question, in my mind, is not the fact of the crisis, but rather the official and institutional responses to it. You can easily argue that most financial crises in US history resulted in a subsequent better rebalancing of the economy and financial system, and I think this is true for many other countries too. For those of us who care about China, it makes sense to think about how these adjustments are likely to occur and what are the best policies for dealing with them when they do occur. Orgulous, given differentials in wealth and growth rates I suspect that we may see immigration, probably illegal, from some of the border countries you mention. On a micro level it might have an impact on wages in the affected areas, but China's population is so large that it would take significant emigration from those countries to make a macro impact. Given political tensions between China and some of its neighbors, I also wonder how it would play out. By Michael Pettis - 2/28/2008 2:36 PM

Orgulous. Actually, the increase of minimal wage may not comes from the shortage of labor in China. I can not see a shortage of labor accross China, but some shortage do exsits in some specific areas like Pearl River Delta due to the lack of labor mobility of China. Thus, a scenario more likely to happen is "illegal labor" from some inland provinces, rather than workers from Cambodia, Burma, or North Korea. By Jerry - 2/28/2008 8:53 PM

Last October I had dinner in Kunming with some people from the local Fujian Chamber of Commerce, and some immigration/border control officials from both Yunnan and Fujian. The Fujian officials were in Yunnan to hand over some illegal Burmese immigrants who had been apprehended in Fujian. Factory wags in Burma, when such work can be gotten, are about US $25 to 30 per month. By semuren - 3/1/2008 5:43 PM