Lou Jiwei, the CEO of the CIC, spoke at a banking forum in Beijing yesterday.According to the SouthChina Morning Post he “calculated that CIC needed to earn at least 300 million yuan a day just to break even because of the 5 per cent interest rate on the special bonds used to finance it.”
A 5% coupon on its RMB funding plus an expected annual RMB appreciation vis a vis the US dollar of anywhere from 7% to 10% means that the CIC needs to earn 12 1/2 to 15 1/2% percent in US dollars just to break even.If they are successful they should immediately leave China and set up a hedge fund in Greenwich, Connecticut.I am pretty sure I could help them raise lots of money.
According to today’s newspapers six independent fuel stations on the mainland that have been illegally selling fuel at prices above the subsidized levels mandated by the government have been fined.I don’t know how prevalent this is but I am pretty certain that even if it is very widespread these higher fuel prices will not show up in the official CPI numbers. Nonetheless Shanghai Securities News says that according to a research report by Guohai Securities, CPI inflation for November is likely to be between 6.6% and 6.8%, which would be above its 11-year high of 6.5% in October.
I have already said in earlier entries why I think that official CPI is understating the real price increases for ordinary Chinese families.First off, food prices have risen by 17-18% year to date, but food’s share of the CPI basket seems to have remained constant in the CPI calculations at roughly 33% of the basket.Chinese families must be spending more on food now than they were at the beginning of the year, and if we adjust the food component up by just 10%, to 36% of the basket, that would have added 0.5% to last month’s CPI number.Of course such a simply adjustment doesn’t correct for the bias, but it does suggest that inflation during 2007, especially since the big food price increases during and after summer, has been worse than what the CPI figures record, and with that real interest rates have been lower.
Second, inflation has had a much bigger impact on students and the urban working class than the numbers suggest.They tend to spend more on food than the average family does.That has a political dimension which lies outside the scope of my blog, but it does suggest why inflation is seen as such an urgent problem.
Growth in reserves continues to astonish. Yesterday the NDRC announced that reserves had hit $1.455 trillion by the end of October.This means they were up $21 billion for the month of October, after rising by $136 billion in the first quarter, $130 billion in the second quarter, and $101 billion in the third quarter, for a total of $388 billion year to date.This compares with a huge $247 billion for all of 2006, and an already very high $209 billion for 2005 and $207 billion for 2004 (the $117 billion increase in reserves in 2003, a big number then, now seems almost insignificant).
We know that the trade surplus for the month was a record $27.1 billion, and FDI inflows were $6.8 billion, which implies that net other flows were a negative $13 billion, but it is hard to figure out how to think about that number.There may have been an additional transfer to the CIC, and it seems that banks and SOEs (and even retail investors) are being encouraged to hold dollars offshore themselves.The total amount of money that came into China in October through the current and capital accounts, in other words, is a lot higher than $21 billion and is probably even a lot higher than $34 billion (because of hot money inflows), but its impact on the PBoC’s balance sheet has been reduced by PBoC transfers to the CIC and by other capital account outflows.
The CIC can be though of as a sort of “second” central bank although dollars held by the CIC are not, strictly speaking, monetized in the same ways that dollars held by the PBoC are.Because it was (or will be) fully funded by an RMB-denominated bond issue, the money creation associated with CIC holdings are fully “sterilized”, and they are sterilized by the issuance of long term MoF bonds, not central bank bills.These MoF bonds still have an expansionary monetary impact, but clearly they are much less money-like than central bank bills, and the effective substitution in the market of these MoF bonds for PBoC bills (the PBoC has indirectly purchased the bonds but plans to use them as part of its open market operations) will reduce money creation somewhat.
If other entities are holding more dollars, this is also good for China because the domestic monetary impact of the foreign currency inflows into China is limited, but we should be careful not to assume that in this case the monetary impact is zero.For example, if banks are holding more of their reserves in dollars, the PBoC has clearly been spared the problem of buying those dollars and so monetizing them, but at the same time those dollar holdings may free up RMB holdings in the banks that can now be used for loan purposes.
In that case I think the positive monetary impact (i.e. the fact that the PBoC did not have to create currency or bills to buy them) might be negligible – foreign currency inflows are still likely to cause an effective increase in domestic money.In general for any company or individual, and not just for the banks, if holding dollars abroad becomes a substitute for holding RMB investments domestically, I would guess that the monetary impact of dollar inflows is still positive and may be substantial.They do not necessarily need to show up on the PBoC’s books for them to affect domestic monetary conditions.I wonder if any of my readers might have any better insight and chime in here.
I don’t know if there is still a lot to transfer from the PBoC to the CIC before the end of the year (altogether $200 billion were to be transferred this year, and I am guessing that at least one-third was already done), but even if there is, total reserve growth at the PBoC plus the CIC will easily exceed $500 billion this year and may even exceed $600 billion.At 17-20% of GDP, this level of reserve growth cannot help but be a serious problem for domestic monetary policy.
The headline in today’s South China Morning Post put it succinctly enough:“HK and Shanghai surge 4pc on rate-cut hopes”.Suggestions Thursday evening by Fed Chairman Ben Bernanke that US rates might be lowered again lifted markets around the world, and China was no exception.Shanghai surged 4.16% to 5003 and Shenzhen climbed 3.06% to 1257 (Hang Seng was up 4.06% and Nikkei-225 was up 2.38%).
Not long ago there was very little correlation between the mainland markets and overseas markets, but in the past few months the mainland markets have been very affected by events abroad and correlation has surged.Since there aren’t a lot of direct links between mainland and foreign capital markets, thanks to capital restrictions, local markets must be concerned about fundamental economic links between foreign and local economies.They don’t seem to believe in the de-coupling thesis.
At $11.14 a bushel, which it reached yesterday in Chicago, soybean prices have risen to their highest level since 1973.Not only do high global prices directly affect the price of food in China – as the world’s largest importer China imports 40% of all tradable soybeans – but 80% of the crop is apparently processed into food for livestock, so high prices will impact the price of pork, beef and lamb.An article in today’s FinancialTimes suggest that there may be more upward pressure on prices because of bad weather in Brazil and lower acreage in the US.Corn prices at current levels imply that soybeans might need to go up another 10% or more before US farmers start shifting out of corn and back into soybeans.
The Chinese government had temporarily (until December) reduced their soybean tariffs from 3% to 1% in order to encourage imports and so keep local food prices down, but price increases in the international markets are already greater than any reduction in the tariff and are likely to go up even more.None of this is good news for domestic inflation.
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.
Subscribe to this Site
January, 2008
.