My Blog

June 2, 2008

There is an article in this week’s Caijing that summarizes a survey by Deutsche Bank’s Jun Ma (here, for those who can read Chinese).  I haven’t managed to get it translated yet but blog participant Kar Kheng Giam summarized it for me as:

Key points:
For those with 'business' connections/enterprises: 52% opted to bring money in as 'FDI', and 11% as under-invoicing.  For those who bring money the old fashioned ways: 85% use either US$50,000 per person per year, using multiple relatives and friends, or the RMB80000 per day TT limit.  57% of respondents forecast RMB to rise to 5.50-6.00.

The survey seems to confirm what we had more or less guessed – there are an awful lot of ways to bring money into China and what is driving the speculative inflows are some pretty ambitious expectations of RMB appreciation.  The very large trade and investment accounts are a particular important channel for hot money and the family businesses with networks both inside and outside the mainland are likely to be particularly efficient at bringing money in (and are likely to be no less so at taking money out again one day). 

The survey also suggests that the “unexplained” portion of reserve accumulation – after backing out the trade surplus, FDI, interest income and revaluation gains – is biased downwards, since there may be substantial amount of hot money in the trade and FDI numbers.  Take this out and add it to the “unexplained” part and the most stable sources of reserve growth – FDI, the trade surplus, and so on – are becoming an increasingly small fraction of total net inflows.  Chinese monetary policy, in other words, is at this point almost entirely driven by hot money inflows.

This is a pretty disturbing conclusion and bears repeating: Chinese monetary policy is largely a function of massive and very volatile speculative inflows driven by RMB appreciation.  

Headline reserve growth for the first four months of this year was a breathtaking $228 billion.  We know that this number understates real inflows because of the redenomination of minimum reserve requirements and the transfer of assets to the CIC, and my best estimate is that adjusting for these reserves would have climbed by $340-370 billion.  Of this approximately $45-50 billion consists of interest income and valuation gains.  The trade surplus and FDI accounts for $94 billion, but almost certainly a large fraction of this consists of disguised hot money. 

Even ignoring the disguised hot money, that still leaves $200-230 billion unexplained.  Part of this unexplained amount will include such things as net tourism and some non-speculative financial transactions, but these aren’t likely to be large numbers, and I suspect that all of them together are probably less than the hot money inflows disguised in the trade and FDI accounts, or at least not a whole lot bigger.  A plausible guess, then, is that hot money inflows are greater than the headline reserve growth, or at least not a whole lot less.

Since the PBoC must monetize these inflows – either by issuing currency or by issuing central bank bills – these inflows end up adding to the country’s money base.  With the largest part of the inflows probably consisting of speculative money, that is what I mean by saying that Chinese monetary policy is now driven primarily by RMB speculation.

Unfortunately I don’t think we are likely to see much improvement in the next few months, and remember anyway that even if there is a reduction in speculative inflows, it would have to be a massive reduction to mean anything.  As money continues to pour into the country, the problems of inflation and overinvestment are going to persist and get worse.  As they do, it will become all the more obvious that China is facing serious appreciation pressure, and the talk of a maxi-revaluation will simply increase.  Needless to say, this can only increase speculative inflows. 

Once again the currency regime has locked the country into a self-reinforcing feedback loop from which it is going to be very difficult to escape.  My hope is that the authorities recognize this quickly and act quickly – and there is some evidence that that an increasing number of senior officials understand the risks.  The next month or two of data will be, as usual, very important, but of course the looming Olympics and the still severe effects of the terrible earthquake limit policy responses.

Caijing also had an article this week (“Real Estate Lenders Warned of Rising Risk”) in which it says that China's overheated housing market is showing signs of a downturn, prompting warnings from bank regulators that bank lending for real estate is carrying an increased degree of risk.  But, according to the article, “some banks may be turning a deaf ear.”

The article goes on the say that the CBRC (the banks’ regulator) is worried that the excessively rapid increase in real estate loans is likely to leave the banks vulnerable to a decline in real estate prices that may already be happening.  I think the increase in risky lending is both a consequence of the country’s monetary policy and a serious constraint on the policy options available to correct those consequences.  Still, the longer this goes on, the riskier loan portfolios are likely to be and the more difficult the necessary adjustment.

Comments (5) for "Chinese monetary policy is d...

The withdrawal/exit option has always been the biggest ? when tackling this topic ; those "exitpoints" highlighted are probably the biggest known "secrets" in the country. YThe big question is how efficient are they going to be when the house of cards are collapsing and presumably heading for the exits. The other big question is which is worse, a boom-bust (accelerated version) upon a maxi-revaluation or accepting problems and losses whilst plodding along the gradual appreciation road, frankly, any liberalisation on the mainland will probably be preceded by the test case of HK, but that's been my argument for ages , probably wrong though. By Judy Yeo - 6/1/2008 9:09 PM

This is absolutely true. My firm has clients who when we tell them that they will have to bring X dollars into China to satisfy the minimum capital requirements for forming their company respond by saying they want to bring in X dollars doubled or tripled. I ask why they want to bring in double or triple what they need to run their business and they say it's not for their business, it's for "investment." By Dan Harris - 6/2/2008 12:17 AM

Could it be that the OUTFLOW of hot money has already started. Falling stock market...Falling real estate market...RMB-appreciation halted at 7,00, then 6,94... By Stefan, Tallinn - 6/2/2008 6:11 AM

The April reserve growth may seem like a buying climax or start of buying climaxes. As the chart goes parabolic, chances are it is unsustainable. That inflow trend is also diverging fundamentally from the deteriorating economic conditions facing stronger headwinds. Maybe China is different but stockmarkets tend to be the harbingers of future conditions, discounting what is ahead. Giving back 60% from its record high in 6 months is serious discounting. Chinese stockmarkets are probably going through a ' grossly oversold' rebounce now that even a once-in-50-years earthquake could not convincingly break. The widespread belief of govt determined to 'protect' the markets prior to the Olympics may explain the lack of selling pressure in the stockmarkets, while the economic fundamentals are not persuasive of serious buying either. However, if indeed RMB grows to 6.0 in 12 mths, and with 12mth FD earning 4%, a total gain of 20% aftertax is still a big lure. By kelaido - 6/2/2008 8:25 AM

FDI flows not doing anything dramatic trade balance in 2008 is actually down on a year in USD terms (think about composition of trade and it is down quite a lot in volume terms) chinese spent billions $ building all the steel factories, and steel exports are down 20-30% on a year all the spec inflows, ending up as deposits and then being lent by the banks... look at the charts and it's a classic too - 2003 is the year when spec inflows picked up (e.g. prasad, wei, 2004) and GFCF/GDP really went into overdrive (to the place where neither JP nor SK been to). how does it end? well, commodity bill is rising. without iron ore, there can't be much building. without oil, not too much petrochem. so then there are subsidies (and hoarding; and smuggling) and lending to intrinsically unprofitable enterprises. how can china afford all this? commodities are all priced in $, and there is no lack of that because of the spec (also - if you are still wondering why $ lending in china is up) so when the specs start to move out (vietnam style), the music stops. banks can't lend anymore because deposits are drawn, commodity purchasing stops, economy slows, unprofitable enterprises end up as NPLs. enter the first serious cleansing of the system from all the rubbish investments. By chegewara - 6/2/2008 8:27 AM