My Blog

December 5, 2007

WED 5 DEC 2007

Global food prices may rise a lot more By Michael Pettis

From today’s Bloomberg:

 

Agricultural commodities may rise by as much as 50 percent next year because of crop shortages and demand from emerging Asian economies, Schroders Plc said.  Corn and palm oil will advance because of “continued” demand for ethanol and vegetable oils to make biofuels, while soybean and coffee may gain on smaller inventories, said Christopher Wyke, product manager at London-based Schroders, which manages $3 billion in commodities.  “The supply-demand balance for these commodities is very tight, which means they're vulnerable to any setbacks in production,” he said in a telephone interview today. He declined to forecast prices.

 

Needless to say this will not help contain food prices in China next year although, on the bright side, declining vegetable prices helped bring Taiwan’s inflation down to 4.50% in November, from 5.34% in October.  I think the decline in Taiwan had to do with local food crops, so I don’t think it will matter much the mainland, and inflation in Taiwan is still running at nearly twice the government target.

 

WED 5 DEC 2007

Will new curbs on bank lending work? By Michael Pettis

It is clear that in the past six months anxiety levels over the pace and nature of China’s economic expansion have risen dramatically.  On Monday Beijing’s top leaders gathered for the three-day Central Economic Conference – an annual event dating, I think, back to the early 1990s, in which members of the CPC Central Committee and the State Council gather to discuss the country’s economic outlook and strategies for the upcoming year.

 

By all reports rising inflation and economic overheating were at the center of the debate (along with equally strong concerns about persistent income inequality).  In the words of yesterday’s China Daily, the leading state-owned English-language newspaper and one not normally prone to voicing excessive alarm about local economic conditions, “China's top leaders gathered in Beijing Monday to determine economic policies for 2008 amid efforts to prevent the economy from overheating and to curb inflation.”  The article goes on to say:

 

In a prelude to the conference, the Political Bureau of CPC Central Committee convened a meeting last week, saying next year's top macroeconomic priorities would be preventing the economy from overheating and the current price rises from evolving into “evident inflation”.  “China would seek steady progress, give priority to good development (over excessive development) and adhere to its reform and opening-up policy,” the Political Bureau was told.

 

At the same time the Chinese Academy of Social Sciences chimed in as it launched the latest of its economic yearbooks with a warning that rising inflation and economic overheating are going to be the government’s worst problems next year.  I haven’t been able to get a copy of the report in English, but here is what the South China Morning Post reports:

 

CASS deputy dean Chen Jiagui said the economy was overheated, judging from the increase in fixed-assets investment and exports, substantial price rises in consumer products and soaring property and stock prices. "It's not easy to slow down because our economy has been in the fast lane. Soaring food prices are spreading to other sectors. The pressure of serious inflation is accumulating," Mr Chen said. "Excessive liquidity and negative real interest rates have fuelled the swelling of asset prices. Macroeconomic controls will be more difficult next year."

 

It seems to me that the conflict between policies aimed at reducing urban unemployment and policies aimed at cooling off the economy are tipping a little more in favor of the latter, although I think the former still outweighs the latter in the minds of many, if not most, senior policy-makers.  This may be changing, however – clearly the monetary alarm bells are ringing loudly.

 

Fair enough, China needs to focus more on tightening measures, but in the immortal words of Nikolai Chernyshevsky, later used as the title of a 1902 work by Lenin (I learned all this stuff in college), what is to be done?

 

From what I hear there will be a lot of more-of-the-same – e.g. interest rate hikes, minimum reserve hikes, sterilization, moral suasion – although as I wrote in an entry on December 1(“More monetary headaches”), the next four months are likely to be especially difficult for monetary management because of the flood of liquidity entering the system.  In particular there has been a lot of discussion over the determination to limit credit growth in the banking system to the level it has achieved this year.  Here is what the Financial Times says:

 

An annual economic policy meeting of top political and economic leaders that wraps up on Wednesday in Beijing is expected to decide to cap the value of new loans that banks can extend in 2008 at the same level as this year.  In the first 10 months of this year, before a crackdown on new loan growth was implemented, domestic and foreign banks in China had extended Rmb3,505bn ($474bn) in new loans.

 

The move would mean that in percentage terms, new bank loans in China would grow by around 13 per cent next year, down from the 15 per cent allowed in recent years, said Chen Xingdong, chief China economist at BNP Paribas.  Ha Jiming, chief economist for China International Capital Corp, said that would represent “a significant tightening.”

 

One official confirmed the bank curbs were on the agenda of the three-day meeting, much of which has been devoted to discussions about inflation and whether the economy is overheating.  The central bank and the banking regulator have already told banks they must keep their net new loans at the level they reached at the end of October, limiting them to lending only what they receive in loan repayments until the end of the year.

 

This is not the first time the authorities have set a cap on loan growth.  They’ve done so every year for the past three years, but usually the limits are busted early in the year and banks lobby for a relaxation of the quota, which is then granted.  This year, however, everyone seems a little more determined to enforce the caps.

 

I think these attempts to cap loan growth, including by more minimum reserve hikes, are going to be at the center of policy responses during the next few months.  There continue to be calls for positive real interest rates – for example yesterday Xia Bin, a research director at the State Council Development and Research Center, said that China must continue increasing interest rates to soak up cash, to increase borrowing costs, and to make the real deposit rate positive, according to Xinhua.   But for all the calls for higher interest rates, I am not sure how much appetite there is to raise rates a whole lot more.  There are rumors that SOEs have been complaining about the huge increase in their borrowing cost this year and I understand that many people, especially at the PBoC, are very worried about the impact of further rate hikes on retail mortgages, most if not all of which are adjustable.  Many mortgage borrowers are already overextended.

 

Will these newly-enforced lending caps work?  My regular readers can probably guess my answer.  I think they won’t have much effect.

 

I am convinced that at the root of China’s problem is the growth in the nation’s money supply caused by the currency regime.  If this monetary expansion is allowed to continue at its furious pace, capping loan growth seems too much like attacking the symptom rather than the source of the disease. 

 

Let us assume that the authorities are indeed strict about enforcing lending caps.  Will this slow the growth of investment in fixed assets, and therefore in industrial production?  I am not sure it will.  If the money supply continues to expand rapidly the money has to show up somewhere.  Might companies simply turn to the stock and bond market instead of banks?  Will banks begin selling off loans (or, especially among smaller, provincial-controlled banks, find ways to hide them?)  Will commercial banks – unwilling to take on deposits that cannot be lent out profitably – encourage money to go elsewhere, for example to China’s already large and thriving, and largely unregulated, informal banking system, or even back into the stock market?

 

Short of directly changing the exchange rate mechanism I think the best thing to do is for Chinese companies to go on an external buying spree, although it is hard to imagine that these companies, inexperienced as they are in risk management, foreign acquisitions, and managing operations abroad, won’t make some seriously poor buying decisions.  At least it will reduce expansionary pressure on the central bank by limiting the amount of foreign exchange it has to buy.

 

I am increasingly convinced that we are going to experience another stock market boom in the first quarter of 2008, as the huge inflow of liquidity caused by the rising trade surplus and maturing domestic liabilities collides with attempts to slow credit growth.  This is also probably going to be a great time for local investment banks involved in fixed income capital markets.  I suspect securitizations will surge as banks try to squeeze out of their lending caps.