My Blog

April 10, 2008

THU 10 APR

Money keeps pouring in By Michael Pettis

The RMB broke through 7 today.  This is pretty much a non-event, in my opinion, but it was treated as a symbolic milestone and some accounts claimed it had psychological importance.  Since the rapid increase in the RMB is a pretty well-established trend by now, I think the only thing that will make me sit up and notice is if it suddenly gaps upward overnight.

 

Much more interesting was the news about the trade surplus and FDI.  The trade surplus for the first three months of the year was $41.6 billion ($19.5, $8.6 and $13.6 billion for January, February and March, respectively), versus $46.3 billion in the first quarter of 2007.  This is the first time the quarterly trade surplus has declined in three years.  

 

Some commentators are suggesting that this decline in the trade surplus is evidence that the credit-related measures to slow the economy and the rising RMB, combined with the global slowdown, are finally having an impact on the trade account.  I am not sure I agree.  First of all it is still not clear whether the full impact of the January storms has worked itself out of the numbers. 

 

Second, and more importantly, for all the worry about how a rising RMB would cripple exporters (and it hasn’t really risen except against the dollar), Chinese exports in fact grew by a very healthy 21.4%.  It is only because export growth has been so phenomenal recently that 21.4% seems like a small number, but it is in fact a very big increase for such a major exporter, and as Chinese exports increasingly dominate their markets it becomes statistically more and more difficult to maintain earlier growth rates.  This “reduction” in the growth rate of exports has nothing to do with the rising RMB or slowing world growth. 

 

Imports grew by 28.6%, and high oil and commodity prices may have accounted for a big chunk of this growth.  According to Mark Williams at Capital Economics, the higher oil bill took out $10 billion in the first quarter of 2008 relative to the same period last year.  Strip this out and we may well see that domestic consumption growth is still not keeping up with production growth – i.e. the trade surplus, which is the gap between the two, would have increased.

 

What was particularly interesting was what happened in the FDI account.  According to the numbers released today, FDI for the first quarter was $27.4 billion – nearly 73% more than the $15.9 billion recorded last year over the same period.  So although the trade surplus declined by $4.7 billion, it was more than matched by the $11.5 billion increase in FDI. 

 

This means that without even counting other net inflows – most especially hot money inflows not accounted for in the trade and FDI numbers – the increase in central bank reserves continues to grow beyond even last year’s unbelievably high numbers.  Remember that January and February reserve growth were (even with the possible $22 billion underreporting caused by the redenomination of bank minimum reserves) the two highest monthly numbers on record, and I suspect that the total increase in reserves for the first quarter of 2008 will be a whopper.

 

We are now caught in the most mechanical and frustrating part of the monetary trap in which China has been caught during the past five years.  The trade surplus was the original driver of China’s out-of-control money growth, but by now the growth seems to have taken a life of its own as money piles into the country seeking to take advantage of the nearly-inevitable run-up in the value of the currency.  Hu Xiaolan, the head of SAFE, said that SAFE and the Ministry of Commerce are going to investigate whether FDI has become a channel for hot money inflows.  Hmmm, I wonder.

 

On perhaps a related note, Xinhua reports today that China’s external debt increased over 2007 by 15.7%.

 

China's foreign debt reached $373.62 billion at the end of 2007, up 15.68 percent over the previous year, the State Administration of Foreign Exchange (SAFE) announced on Wednesday.  China's medium and long-term borrowing totaled $153.53 billion at the end of last year, an increase of $14.17 billion, or 10.17 percent, according to the SAFE.

 

Meanwhile, the country's short-term borrowing increased $36.46 billion to $220.08 billion, up 19.85 percent.  Of the total external debt, $34.89 billion was the sovereign debt; foreign invested enterprises accounted for $74 billion; and the amount for foreign financial institutions in China was $46.31 billion.

Preliminary statistics showed all of China's foreign debt indices were under the international standard safety line in 2007, the SAFE said.

 

I don’t really have much information about the reason for the $50.6 billion increase over the year, and of course there is no way to discern the impact of this borrowing on the country’s reserve position without knowing to what use the funds were put (i.e. were they spent in China or abroad?), but the practical trader in me assumes that even with the easy domestic-currency borrowing conditions it still makes a lot of sense for Chinese companies to fund as much as possible from abroad.  China’s external debt levels are miniscule given the country’s size and, more importantly, reserves, but foreign borrowings are one more source of domestic money growth.

 

Meanwhile the NBSC has revised upward GDP growth for 2007.  It turns out that because of underreporting of growth in the services industry, including telecommunications and retailing, China’s GDP growth for 2007 was actually 11.9%, not 11.4%.  We would like to see services comprise a bigger part of the economy, and this revision is welcome for many reasons.