My Blog

July 24, 2008

In the first half of 2008, according to a Ministry of Commerce release today, investment flows from Hong Kong to the mainland rose by 95% over the same period last year, to $23.4 billion.  Interestingly enough, the number of projects declined by 8.2%, to 6,900.  I suppose it is possible that the average size of each project has more than doubled, but given the large number of projects, I think this is extremely unlikely.  So why the discrepancy?  According to an article in today’s Xinhua:

Given the close trade and economic ties between the Hong Kong Special Administrative Region (SAR) and the mainland, analysts said, at least some of the investment might be speculative funds.

It very well might.  The article goes on to say that Ministry of Commerce figures indicate that since 1978, 40.7% of all FDI entering China, or $331.9 billion, was sourced through Hong Kong.   

FDI in the first half of last year amounted to $36.0 billion, if I remember correctly, so using these Ministry of Commerce numbers I calculate that Hong Kong accounted for around 33% of that total.  For the first six months of 2008 FDI amounted to $52.4 billion, and the Ministry of Commerce numbers suggest that Hong Kong accounted for 45% of the total. 

If I am doing my calculations correctly this implies that the increase in Hong-Kong-sourced inflows accounted for 69% of the total increase in 2008 year to date.  Given that last year HK accounted for only 33% of FDI, contributing 69% of what was a large overall increase means that Hong Kong investors are clearly playing a disproportionately large role in that increase.

Of course I can’t prove it, but for all the obvious reasons it is probably safe to say that most of the hot money coming into the mainland comes from Hong Kong, from Taiwan, and from Chinese family business networks, so the fact that Hong Kong accounts for such a disproportionately large share of the rise in FDI is, at the very least, suspicious.  I think this is clearly more evidence, if any is needed, that much of the money coming into China is speculative.

By the way according to the Ministry of Commerce release, investment abroad by Chinese companies more than tripled in the first half or 2008 (up 229.5%), relative to the same period in 2007, to $25.7 billion.  I think this is pretty impressive, especially given that investing abroad is a tough proposition when you have an undervalued and appreciating currency.  The release did not specify how much of this investment was funded abroad, but I suspect much of it was, so the domestic monetary benefits of this outward investment are probably pretty limited.

Meanwhile the local stock markets seem to be in a less gloomy mood than they have been during the past few months.  The two strongly positive days (Monday and today) and the two mildly negative days have left the SSE Composite – which closed today at 2910 – up 4.75% so far this week.  Part of the improvement is probably due to declining international oil prices, but given that financials have been the leaders, I think that most of the improvement comes from speculation that inflation may be easing, or at least that the authorities are likely to take pressure off the monetary side in their bid to promote growth.

By the way I heard confirmation today from another friend of the rumors to which I referred earlier this week – that the infighting between the two main policy-making camps has gotten so fierce and so visible that part of the purpose of the recent leadership meeting was to broker a compromise and calm things down.  Unfortunately given the apparent current tilt towards “growth” within the leadership, I do not think this controversy is going to die down, and I expect that rising inflation later this year will re-ignite it.

This week’s rising bank stocks prices don’t mean that there isn’t nervousness in atleast some quarters about credit risks.  According to Jamil Anderlini in today’s Financial Times (“China’s banks told to tighten mortgages”):

Chinese officials and government economists have warned domestic banks to tighten their mortgage lending criteria after the US government’s action to prop up Fannie Mae and Freddie Mac, the giant mortgage agencies.  

Liu Mingkang, China’s top banking regulator, has in recent days urged the country’s state-owned commercial banks to beware of risks in the real estate sector and ordered them to tighten loan approval processes.  Others among China’s policy community have also begun to express concerns about the health of the country’s banks amid signs a once-booming property sector has begun to slow

Jamil goes on to quote Yi Xianrong, at the China Academy of Social Sciences, as making the very sensible observation that “If financial institutions of Freddie Mac and Fannie Mae’s calibre could get into such a bad situation, then what does that mean for Chinese financial institutions?  The only reason we haven’t seen similar problems here is because property prices have continued to rise rapidly.” 

Needless to say I think Mr. Yi is absolutely correct, and I expect that he will have proven to be when and if ( and I really just mean “when”) we see a serious monetary or economic contraction.  He elaborates:  “Anyone can get a mortgage loan in China, no matter who they are. There is also a huge amount of speculation in the market and insider dealing when it comes to bank officers granting loans.”

In that context I heard from a normally plugged-in friend of mine that the authorities are planning to reshuffle the top positions in the big banks after the Olympics.  My friend tells me that the new leaders are likely to be more sympathetic to industrial and provincial leaders’ beliefs that slowing growth is a bigger worry than rising inflation.  If true, I think we can expect to see deterioration in the credit quality of bank portfolios, even as they take on more market risk.

SASAC already announced yesterday that “China will restructure centrally administered state-owned enterprises after the Beijing Olympics”, according to Xinhua.  Perhaps this has something to do with the fact that profits at centrally administered SOEs are down 10.3% in the first half of 2008 (compared to up 30.9% last year).  I am not much of an expert on the industrial sector, and I don’t have a lot to say about this, but I was interested to see that Dong Tao at Credit Suisse says that this may indicate inflationary pressures:

We believe the weakened profit growth at the SOEs is a major concern. It suggests continued rising production costs and increasing pressures caused by the government’s caps on fuel prices and power tariffs.  Besides surging prices of raw materials, rising inflation expectations are leading to an acceleration in wage growth, in our view.  In addition, the continued losses in the oil refining and power production sectors have led to a further deterioration in fuel and power supplies. This may force Beijing to raise fuel prices and power tariffs again after the Olympics.  The shift in the source of inflation is of real concern, and we do not rule out the possibility of a second round of inflation as cost pressures continue to build.

Comments (9) for "Hot money and inflation risk...

Deutsche Bank Research sees a rising trend of overheating: "The slowing headline inflation in May was due mainly to a slower increase in food prices to 20% yoy compared to 22% in April. Components of the demand-pushed factors in our COI model – imports, retail sales, industrial sales, money supply and credit growth – all recorded strong double-digit growth." (...) "Looking ahead, the hike in fuel prices, which pushes up retail fuel prices by around 15%, will keep headline inflation high even as food prices continue to rise at slower rates. High inflation together with robust growth in monetary data, investment and consumption will support further tightening moves, which may include a hike in interest rates toward the end of Q3 or in Q4 this year." http://www.dbresearch.com/PROD/DBR_INTERNET_DE-PROD/PROD0000000000227837.pdf By Gregor Neumann - 7/23/2008 6:41 PM

Hi Michael, I am curious to know if Chinese M2 annual growth rate of 18% is adjusted for inflation? If not, couldn´t one claim that this is very reasonable, i.e. non-inflationary, monetary expasion for a country that is growing 10% yoy with 7% inflation? Even if it is adjusted for inflation, wouldn´t one expect increased use of monetary means of exchange by growing urbanization, industrialization and development generally? Thank you for your insights! Best, EG By Eduardo Guelman - 7/24/2008 2:49 AM

Michael: Gary Schilling has made the point that China can not decouple from the United States yet due to there being by his calculations, only 110 million people with incomes over $5000 US American dollar equivalents in China and these consumers can not replace the 240 million consumers in the United States that are in the midst of a pull back. His call is for a deep slow down in the US that eventually effects the rest of the World. Other economists or more optomistic concerning China and India's abilities to grow without the help from US consumers. Where do you stand one this question? By dmg555 - 7/24/2008 8:18 AM

dmg555: Do you have a cite to that stat? Didn't come up in Google, at least the first couple of pages. It sounds interesting, even more so as many on Wall St. think China will save the NASDAQ 100 by swallowing lots of iPhones and other expensive tech. By Mike Guidry - 7/24/2008 11:07 AM

Mike : I listened to Gary Schilling on Bloomberg and wrote down his numbers. Mr Schilling cited his own proprietary reseach. By DMG555 - 7/24/2008 8:49 PM

dmg555: Thanks, searched Bloomberg and found it. BTW, there's no "c" in Shilling. I can't say I'm surprised at his estimate, although I've never seen any research on it. Michael Pettis: Do you have any stats on the issue? Thanks. By Mike Guidry - 7/24/2008 9:58 PM

Personally I do not think that the bulk of the hot money comes from Chinese family networks. Much of it certainly does, but the numbers we are seeing are just too large. I think the bulk of the hot money comes of accounts controlled by PRC corporations that are repatriating dollars that in years past would have remained in Hong Kong. By Twofish - 7/25/2008 2:58 PM

EG, I discuss this a little more broadly in my July 10 entry. 18% is nominal growth, but more and more banking activity seems to be occurring outside the formal banking sector, and I am not sure if M2 captures that very well (I would welcome a discussion on that topic). In addition, any money growth is taking place from a very high base -- M2 is I believe about 160-170% of GDP. Twofish, you may be right, but that would come as a surprise to a lot of people I talk to, including HK businessmen. I would also have guessed that if you are right, the PBoC and SAFE would have had much better ways of limiting those inflows than the current measures they have taken on monitoring trade and FDI. By Michael Pettis - 7/27/2008 6:47 PM

DMG555, I have never been optimistic about the decoupling thesis. I have seen economists in a lot of countries argue that as their exports to the US have become a declining share of their total exports, this is evidence that they are less sensitive to US demand. Perhaps. It may also simply be evidence of globalization in trade, with products being processed in ever more countries before arriving at the ultimate consumer. I remember two years ago I checked the stats, and although I don’t have them readily available, it seemed that the US trade deficit as a share of total GDP had grown dramatically in the last decade. This suggests to me that the Rest-of-the-World is more dependent, not less dependent, on US demand. That is why I am pretty certain that the declining share of exports going to the US – which so many countries have experienced – does not suggest at all the declining importance of US consumers to global demand. One place to watch this is inventory levels. In the past given strong growth in the US (and the world) Chinese overcapacity could be exported abroad. This may become increasingly difficult, and as a consequence we may see inventories rise. By Michael Pettis - 7/27/2008 6:56 PM