My Blog

December 17, 2007

MON 17 DEC 2007

Don’t turn the shower faucet to hot too quickly By Michael Pettis

Yesterday the State-owned Assets Supervision and Administration Commission (SASAC) announced they would require dividend payments from after-tax earnings for state owned enterprises.  Although commercial-bank lending constraints seem to be partially working, there has been no real reduction in fixed asset investment in China as of yet (the November reduction seems to have been more of a statistical effect).  This may be because informal and illegal banks, leasing companies, and direct investment have expanded by more than enough to take up the lending slack, and it seems pretty clear that large amounts of retained earnings are being plowed back into investment even in cases where the economic rationale for doing so is dubious.

 

To address the latter, and to reduce the amount of cash available for re-investment, SASAC is requiring state-owned companies to pay a share of their profits to the government in the form of a dividend.  Just over three-quarters of the 151 firms administered by SASAC will pay dividends equal to between 5% and 10% of after-tax profits.

 

I am not sure this is enough to make much of a difference.  According to today’s South China Morning Post “Two finance ministry officials reportedly said in June that the maximum payout ratio would be 20 per cent. They said some 60 billion yuan could be raised if an average 10 per cent payout ratio was applied.”  Transferring less than $8 billion from corporate retained earnings to the government won’t make much of a dent on investment, which exceeds $1 trillion annually, and anyway the transfer will reduce the government deficit and, along with it, government borrowing.  In that case it might free up as much new money in the bond markets as it withdraws from retained earnings.  Still, given the concerns I have about a sudden jump in contingent liabilities from the banking system if there is a sharp adjustment in the Chinese economy, I am glad to see anything that reduces government debt.

 

Of course there are also more rumors running around about additional PBoC actions and finger-wagging to slow the economy.  The PBoC is clearly considering more minimum reserve and interest rate hikes, but now there is talk of “differentiated” reserve requirements – that is different requirements for the larger banks, who take in more deposits as a share of funding than the smaller banks, or higher reserve requirements for new deposits.  It will be very interesting to see if these new measures make taking deposits less profitable for banks and so create incentives for them to discourage additional deposit growth.  This might have the effect of simply channeling monetary expansion into areas where the PBoC has a more difficult time controlling and regulating.  By the way deposits grew rapidly in November.

 

The PBoC actions are definitely hurting property speculation. Gerry Xu Feng, the chief officer of the research department at Midland China in Shenzhen, said, according to the SCMP, that about 10% of the 30,000 estate agents in Shenzhen had quit their jobs.  I guess it is getting harder to make a living churning property.  Real estate prices are reportedly lower in the main cities, and property developers have been among the worst performers in the domestic stock markets. 

 

We all want to see a slowdown in property speculation, of course, but many people, including me, wonder about exactly how much exposure the banks have to the property sector (direct exposure is high enough, but there is anecdotal evidence that indirect and hidden exposure is also extremely high).  The danger of all these attempts to slow property speculation and other effects of excess monetary expansion may make China like the bather, in an analogy attributed to Milton Friedman, who gets scalded after turning the hot water all the way up in a chilly shower.  Because of the lags and the difficulty of transmitting monetary policy into the non-coastal provinces (where a very interesting study I read last month – I can’t remember the citation – suggests that there are problems with the transmission mechanism for PBoC monetary policy), the belated attempt to get out of the freezing water of property speculation may lead to the scalding water of a surge in real-estate-related non-performing loans.  There really are no easy or obvious policies for the PBoC to pursue as long as their currency regime imports such massive amounts of liquidity.