Tag Archives: economics

A Disdainful View From Beijing On America’s Debt Ceiling Debate

China has made little secret of its disdain for the way the U.S. political establishment has handled the debate over raising the federal government’s debt ceiling. These extracts from an article carried by Xinhua captures the tone:

The months-long tug of war between Democrats and Republicans, however, failed to defuse Washington’s debt bomb for good, only delaying an immediate detonation by making the fuse an inch longer…

Meanwhile, the madcap farce of brinkmanship has disclosed yet another ticking bomb in the heartland of the sole superpower in the world — the crippling tendency to politicize the economics while trivializing the politics…

Should Washington continue turning a blind eye to its runaway debt addiction, its already tarnished credibility will lose more luster, which might eventually detonate the debt bomb and jeopardize the well-being of hundreds of millions of families within and beyond the U.S. borders…

Whether Washington’s political elite, intent on grabbing maximum political gain, intended the chaos or not, it is advisable that one should not mess around on the edge of an abyss. Given the heft of the United States, such a dangerous practice is tantamount to a bomb of mass destruction. If left unattended, it might explode, and the whole world will have to deal with the shock waves.

Meanwhile, while Americans wring their hands over whether their credit rating agencies will downgrade their country’s AAA rating despite the deal the U.S. Congress has passed, Chinese rating agency Dagong has gone ahead and done so. It downgraded the U.S.’s credit rating from A+ to A, with a negative outlook. China is the largest foreign holder of U.S. government debt, at $1.15 trillion in May. It has been trying quietly to scale back the growth in its exposure, though, truth be told, with the euro in crisis, it doesn’t have a lot of overly attractive alternatives so is stuck with what it has got.

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Third Quarter Economic Outlook

As we head into the third quarter, it is what lies under the surface that attracts our interest. On the economy, the anti-inflation measures are slowly, slowly starting to have some effect but the economy won’t decelerate to the extent that it will meet the government’s stated 7% GDP growth rate for the year. Property is still buoyant. We still expect growth for the year to be in the high 8% range, with third quarter growth at 9%. We also think Beijing would be more than happy with 8%+ growth for the year, given the fragility that persists in the world economy.

We expect banks’ reserve ratios, interest rates and the yuan all to rise further throughout the rest of the year, with the inflation rate coming off its mid-year highs by September, providing the arrival of rains this weekend doesn’t presage a false end to the drought that has hit the farmlands of central China and along the Yangtze valley. We suspect that the impact on grain crops, in particular, will be greater than the optimistic official expressions allow, but there are reserve stocks to dip into.

The drought is also causing the seasonal power shortages to occur in those industrial areas supplied by hydropower sooner than usual and they are likely to be deeper than is customary, but industry is not working flat enough out for them to affect output significantly. Demand from reconstructing Japan should start to boost exports, offsetting in some part weak demand in the West. The Party’s 90th birthday bash in July should also give domestic demand a transitory boost.

Beneath the surface lies, as ever, the risk of the property bubble going bursting, or the local government debt bomb exploding, the two are so closely linked that the one would likely trigger the other, and the conjoined twins are the banking system’s greatest vulnerabilities.

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The Double Concern Of Western China’s High Inflation

Here is an example of the glaring weakness to monetary management by administrative measures. The central bank is trying to cut off inflation-stoking bank lending by reducing the quantity of money available to be lent out. Hence the hiking of banks’ reserve requirements and guidance to banks on where to lend. However, western provinces are exempted because of another of Beijing’s policy priorities, development to reduce wealth disparities with the eastern coast. That means lending for capital intensive natural resource and infrastructure projects. Meanwhile, direct subsidies and other welfare transfer payments for healthcare and housing continue. The result of this torrent of new cash flooding in: the inflation rate in most western provinces is now running above the national average of 5.4%. It is more than 9% in Ningxia, Qinghai and Tibet and more than 6% in Sichuan and Gansu.

The provincial inflation figures may underestimate the problem. (We would probably be more surprised if they didn’t.) In Ningxia the minimum wage was raised at the start of April by 24.9%, eye-popping even by the standards of some hefty minimum wage hikes that we have seen over the past months. Local officials said it was to accommodate rising living costs. At the other end of the country, there are signs that inflation is starting to cool, notably in the northeast, around the Bohai rim, a harbinger of the national inflation rate slowing its growth during the course of this year. The west will be on the distant trailing edge of that arc. Ningxia and all the western provinces are those that most worry Beijing when it comes to social stability. Persistent inflation will only double that concern.

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Central Bank Transparency: Tell ‘Em More; Keep ‘Em Guessing

U.S. Federal Reserve chairman Ben Bernanke’s decision to hold press conferences after every other Fed’s interest-setting committee meetings set us thinking about central bank transparency in general and that of the People’s Bank of China (PBOC) in particular. How much is needed for effective policy making and what impact does being more open have on which aspects of it?

Beyond doubt central banks have become more transparent over the past two decades. Publics expect more accountability from government institutions that are, for good reason, insulated from standard political oversight. Central bankers have found that being more open makes their exercise of monetary policy easier. Markets become less skittish the more they know, an assertion backed by a growing body of academic research. Communication improves the predictability of monetary policy, thereby lessening financial market volatility and contributing to a more stable economy. In particular, greater transparency improves central banks’ ability to manage inflation expectations and thus makes inflation less volatile, if not necessarily less persistent.

That benefit of transparency alone should pique the interest of the People’s Bank of China. It is less open, we would hazard, than its counterparts in the other large economies. Government has long preferred more secrecy in monetary policy to less, which leaves it with more flexibility to guide the economy. In the mid-2000s, two economists, Nergiz Dincer and Barry Eichengreen, devised a central bank transparency index covering 100 countries. New Zealand’s central bank was most open, rating a 13.5 on the index, the Bank of England was a 12, the European Central Bank was an 11.5 and the Fed a 9.5, the same as the Bank of Japan. The PBOC came in at 4.5.

That score was a huge improvement on the 1 it had rated at the start of the decade. However, an update in 2009 by Dincer and Eichengreen to their work did little to suggest much change in the absolute rankings or the broad findings that central banks in developed economies that were politically stable tended to be most transparent, and that having a flexible exchange rate was a driver for greater transparency for reasons of public accountability.

The PBOC publishes an every wider range of data and reports on its web site as befits the increasingly central role it has taken in the macro management of the economy in the 2000s, but recent research by German economist Rolf Knütter and colleagues finds that statements and press conferences are more effective than long written reports in communicating a central bank’s intentions to financial markets. Hence the bookish and, for a central banker, limelight loving Bernanke’s decision. Press conferences tend to pull out the whys of policymaking, to augment the published whats. The PBOC is reckoned to be better at revealing the whats than the whys; its economic transparency is greater than its policy transparency which in turn is greater than its procedural transparency.

The PBOC has alternative channels of internal guidance to domestic financial institutions and markets. As those internationalize and liberalize, those channels will be increasingly inadequate channels of communication. One example that has has market participants complaining about the PBOC’s transparency weaknesses is the current round of monetary tightening. The first rise in the current series of interest rate increases last October caught money markets off-guard, as did many of the subsequent rate rises and increases in banks’ reserve ratios. Volatility in money market rates has increased in the face of market uncertainty about the central bank’s tightening intentions. The surprise rate rise announced just ahead of New Year, a time when cash is in high demand, caused the benchmark money market rates to spike by a record amount (242 basis point in one day). This forced the PBOC to inject cash into the money markets, negating its attempts to dampen inflation by mopping up liquidity though raising reserve requirements.

Similarly, as the exchange rate for the yuan becomes more flexible, that will enhance the independence of monetary policy and thus the importance of transparency to increase policy credibility and the central bank’s management of inflation expectations. The transparency of the PBOC could prove an informal indicator of the progress of market-oriented reforms in monetary policy.

Not all economists believe that greater transparency is an unalloyed public good. If it reveals divisions among policy makers or a low degree of confidence in the basis of monetary policy decisions, that can rattle markets. Central banks have more information about an economy than most investors. If investors doubt the robustness of the data or the analysis on which those decisions are being made, it can alter inflation expectations. That could have a direct impact on long-term interest rates, which in turn could determine the path of current and future consumption and investment.

In the event of a speculative attack on a currency, transparency can become an even more dangerous double-edged sword. Wharton finance professor Itay Goldstein and colleagues found that if all speculators in financial markets perfectly understand a central bank’s future course of action, the central bank may not get back market signals as good as it needs in making policy decisions. That risks policy mistakes. What central bankers then need to do, Goldstein suggests, is to surround their signals with some noise, so there are conflicting interpretations of what a central bank’s intentions truly are. That bit of greater transparency, at least, Beijing’s policymakers appear to have perfected.

Overall, the benefits of more transparency to central banks are greater than the risks. The Fed’s Bernanke is playing catch-up to his European counterparts. The PBOC has even more ground to make up.

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Exports Said Important, Not Dominant Driver of China’s Growth

McKinsey, the management consultancy, is recirculating a recalculation it published last September of the value of China’s exports that strips out the value of imported components and semi-manufactures that get assembled into final export products. It is worth another look at the exercise, which was intended to create a truer picture of the dependency of China on exports for its economic growth and thus take a better measure of the strength of the shift to domestic demand now underway.

Arithmetically, what McKinsey calls domestic value-added exports will have to be a smaller percentage than the standard export numbers show (unless Chinese export manufacturers destroy value), so the interest lies in the scale of the reduction. What the firm found is that domestic value-added exports contributed 19%-33% of total GDP growth from 2002 to 2008, almost half the contribution indicated by the conventional numbers. So exports are an “important” but not “dominant” contributor to growth, McKinsey concludes.

One other inference to be drawn from the calculations is that China’s export manufacturers are moving up the value chain and becoming less pure assemblers, which is in line with the observable evidence. “If your company is a manufacturer in China that is primarily processing intermediate components for reexport…it’s probably time to consider alternative locations for the assembly work,” McKinsey advises.

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China Again Raises Banks’ Capital Reserve Ratios

China’s anti-inflation ratchet is clicking ever more frequently. The People’s Bank of China is again raising banks’ capital reserve-ratios. An increase of half a percentage point will come into effect on February 24th, taking the ratio to 19.5% for most large banks, and 20% for some.

It is the second time this year that the reserve ratio has been raised and eighth time over the past two years. It follows an increase in benchmark interest rates earlier this month (the third since the central bank started raising rates last October) and a January consumer price inflation number, 4.9%, which dashed any lingering hopes that inflation had peaked last November.

The central bank has been struggling to drain off the excess liquidity in the system. New bank lending in January was 1.04 billion yuan ($158 billion). The early months of the year tend to see a surge in new lending as banks clear their backlog of applications held from the previous month so they could stay in touch with their annual lending quota. But on top of the growing trade surplus swelling China’s foreign-exchange reserves and the yuan not appreciating that quickly to compensate, this means the central bank is facing an uphill battle to sterilize all those funds. We expect the click-click of the ratchet to continue.

 

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However You Mix The Basket, China’s Inflation Persists

Inflation hasn’t continued its decline from November’s peak, as policy makers had hoped and most analysts doubted. The Consumer Price Inflation number for January has come in at 4.9%, closer to November’s 5.1% than December’s 4.6%, if less than the 5.3% consensus forecast.

Beijing has deployed an old trick: changing the mix of the basket of consumer goods whose prices it samples. It does this every five years. This time, food has been given less weight; property and services more. The National Bureau of Statistics says this has not significantly changed the January number; it actually pushed it up by 0.024 percentage points (see NBS’s chart below). Whatever. The change will certainly have mitigated the 10.3% month-on-month jump in food prices.

What is clear is that inflation is running above target (4% for 2011), is responding slowly to the steady ratcheting up of measures to contain it and that more tightening such as another round of interest rate rises to follow the one earlier this month is likely sooner rather than later.

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