China’s nerves on edge over inflation

By Eadie Chen
Reuters
Sunday, January 13, 2008; 1:50 AM

BEIJING (Reuters) – Chinese policy makers will have a tough time in 2008 battling inflation, excess liquidity and rapid investment, Vice Finance Minister Li Yong said on Sunday.

China has taken a series of measures such as cutting export tax rebates and tightening investment criteria to cool an economy that expanded 11.5 percent in the first nine months of 2007 compared with a year earlier.

The central bank also raised interest rates six times last year and ordered banks on 10 occasions to set aside more deposits in reserve.

“Although these policies are working well, there is still a shortfall from the desired and expected effects,” Li told a forum.

Consumer prices rose 6.9 percent in the year to November, the fastest pace in a decade, setting alarm bells ringing in the halls of power.

Chen Jiagui, vice head of the Chinese Academy of Social Sciences, said the State Council, or cabinet, held an emergency price meeting last Friday and would hold another one on Monday.

The State Council said after yet another conclave devoted to inflation last Wednesday that it would keep a freeze on energy prices and would temporarily intervene directly in the market to hold down prices of daily necessities.

With climbing global grain and raw material prices adding to domestic price pressures, China’s year-average inflation could be as high as 4.6 percent in 2008, Xu Lin, a senior official from the National Development and Reform Commission, said on the sidelines of the forum.

That would match the rate for the first 11 months of 2007.

HANDS TIED

Li said inflationary pressure was still mounting, but China now had less room for maneuver even though it shifted its monetary stance in early December to “tight” from “prudent.”

Banks’ reserve requirements were already at a historical high of 14.5 percent, while it was difficult to raise interest rates further given that rates are falling in countries such as the United States, Li said.

Even without an attractive interest rate differential, the U.S. credit crisis could trigger unwanted speculative capital flows into China, especially at a time when global investors view emerging markets as a relatively safe haven, he said.

Li said China’s trade surplus, which rose 48 percent last year to a record $262.2 billion, was likely to remain elevated in the first half of 2008, adding to liquidity in the banking system.

With the yuan also on an appreciating track, the problem of excess liquidity was unlikely to fundamentally ease any time soon, the official warned.

Li said the impetus behind fixed-asset investment remained strong as the large number of projects launched in 2007 would require continued capital spending this year.

Closer coordination of fiscal and monetary policy was needed to tackle the array of problems, Li said.

The Finance Ministry is considering issuing more types of treasury bonds so that the central bank has a broader range of paper with which it can conduct open market operations, Li said.

Speaking at the same forum, newly promoted deputy central bank governor Yi Gang said the People’s Bank of China would fight inflation by further tightening monetary policy, but it would do so cautiously to ensure stable economic growth.

“We will unwaveringly fight against inflation and implement a tightening policy. But we will make sound arrangements to ensure fairly stable economic growth,” Yi told reporters.

Chinese property and share prices, though very high in some cases, were close to their equilibrium levels, he added.

(Reporting by Eadie Chen; Editing by Alan Wheatley and Ken Wills)

China: Can the rabbit bound free of the forces of destruction?

China: Can the rabbit bound free of the forces of destruction?
Officially 2008 is the Chinese year of the rat, but if its booming economy is to avoid being mired in a global downturn, the country will have to pull a different animal out of its hat. Tessa Thorniley reports
Published: 06 January 2008
China: Can the rabbit bound free of the forces of destruction? Monuments to Mammon: but the boom in Beijing could be stopped in its tracks

There is a Chinese proverb about cunning that runs: “A sly rabbit will have three openings to its den.”

Few would argue against the wisdom of having good contingency plans in place, but on the flipside, the saying leaves open the possibility that even the slickest bunny could be caught out by a determined three-prong attack.

And China – according to several leading economists – is facing just such an onslaught. The attacks come from a shaky Wall Street and slower US economic growth, a tighter domestic money supply and, longer term, developing world cutbacks in investment. This unhappy trio of factors is expected to lead to a significant slowdown in the Chinese economy in 2008-09.

As the new year gets underway with the markets mired in a global credit crunch, the question being asked is whether the Chinese rabbit will be able to shake free from these threats in 2008 and continue to bound forward, or whether it will find itself trapped in a hole.

China is now a crucial part of the world economy – even international investment banks such as Morgan Stanley have turned to it for funding in the form of a $5bn (£2.5bn) cash injection from sovereign fund the China Investment Corporation. So the reverberations are likely to be felt globally and the signs are not looking good.

At the end of last year, the Asian Development Bank cut China’s GDPgrowth forecast to 10.5 per cent from 11.4 per cent in 2007. Several economists, such as Mingchun Sun, senior China economist at Lehman Brothers, go further, predicting that growth in 2008 will drop below double digits for the first time in six years. Mr Sun is forecasting Chinese GDP growth of 9.8 per cent this year.

“If it slips below 8 per cent – and I am forecasting 8.8 per cent in the fourth quarter this year – that will hit China very hard. There will be a negative output gap that would hit jobs. For China, growth of around 9 per cent is necessary for the economy to remain healthy,” says Mr Sun.

Most of the economic fears in the People’s Republic spring from concern about the slowdown in growth from its biggest source of demand: America. “While the US may not be China’s biggest trading partner now – that is Europe by a whisker – it is still the lynchpin of the global economy” says Stephen Green, senior economist at Standard Chartered.

“We have already seen export growth to the US from China slow from 35 per cent year-on-year to around 6 per cent. The forecasts for lower growth in China stem from expectations about falling exports.” Mr Green adds.

Combined with an expected slowdown in European growth – along with domestic measures designed to tighten Chinese banks’ lending, rising interest rates and a strengthening currency against the dollar – China is heading for some challenging times.

Fears are also growing that slowing exports will pop China’s investment bubble.

“So far, global growth and exports have masked the fact that there is severe overcapacity in China. Less exports, and inventory stockpiles could lead to aggressive price cuts, potentially hitting companies’ profitability and ability to repay bank loans,” says Mr Sun.

By the time China hosts the Olympic Games in August, the boom times within the current economic cycle could just be coming to an end. As China is the world’s second-largest economy and, according to the World Trade Organisation, is expected to overtake Germany as the world’s largest exporter this year, the global impact is likely to be marked.

Although its stock market had fallen back by around 15 per cent from its peak of 6,124.04 in mid-November, 2007 was still a record for flotations in China.

Chinese companies raised around $100bn through initial public offerings (IPOs), with an estimated $65m raised by A-share listings in Shanghai or Shenzhen and the bulk of the remainder via H-share listings in Hong Kong. By contrast, companies in the world’s other hot econ-omy, India, which also enjoyed a record year for IPOs, only raised a combined $7.7bn.

Despite the worries about the global economy, bankers expect a broader range of Chinese companies to try and tap the capital markets this year, after Petro China and China Shenhua Energy raised almost $18bn between them last year. However, they will not find it as easy as it was in 2007.

As reported on Xinhua, the state news agency, the primary task of China’s 2008 fiscal pol-icy is “to prevent the economy from becoming overheated and to guard against a shift from structural price rises to evident inflation”. Inflationary fears – stemming from China’s yawning trade surplus (of around $280bn) – prompted the central bank to raise interest rates for the sixth time in a year in December. In the previous month, inflation was running at 6.9 per cent, the highest for 11 years.

But if the forecasters are right, lower exports, a smaller trade surplus and a tighter money supply could quickly dampen any inflationary anxiety.

“Although last year there was concern about inflation, let’s not forget that not long ago China suffered several years of deflation. If the global slowdown takes hold and there is over-capacity, it is possible we could see deflation again in China in 2009,” says Mr Sun.

Last year, one of the biggest inflationary pressures was rocketing pork prices – which were up more than 50 per cent at their peak – after a disease called Blue Ear devastated herds. Food accounts for more than 30 per cent of China’s consumner price index basket – the collection of goods that is used to measure prices – compared with around 10 per cent for the UK.

“Pork prices fell back quite sharply after October. But they started to climb again at the end of December,” says Mr Green.

Property prices have shown an equally runaway tendency, up 30 per cent over the past year in hotspots such as Shanghai.

Soaring asset prices have prompted Beijing’s central planners to implement tighter monetary policy, not only by raising interest rates but also by boosting the ratio of reserves that banks must set aside as deposits.

While the Chinese authorities and the People’s Bank can do very little to prevent the widely anticipated American – or global – slowdown, the challenge facing them in 2008 will be to strike the right balance between reining in the econ-omy so it does not overheat, and not pulling back so hard that growth is stopped in its tracks.

As the US splutters, the world is hoping that this is a rabbit China can pull out of its hat.