My Blog

February 28, 2008

THU 28 FEB

More warnings on inflation vigilance in China By Michael Pettis

The State Information Center, a think tank affiliated with the National Development and Reform Commission, the country's top planning agency, has weighed into the policy debate by recommending that the government maintain its tightening monetary policy.  It said that the government might consider relaxing the measures over the short term because of last month’s horrific weather crisis, whose economic impact nonetheless is likely to be “limited and temporary”, but that ultimately policymakers should continue with prudent fiscal policy and tight monetary policy.  In the same report they predicted that CPI inflation for the first quarter would be 6.9%

 

I have already pointed out many times that I don’t believe monetary policy can be tight until the currency regime is fixed and capital inflows sharply reduced, which is not what the authorities are contemplating.  I also think 6.9% for the quarter is overly optimistic, although perhaps announcing this estimate as their expectation may just be part of the campaign against rising inflationary expectations (although if this is the case it does nothing to help their credibility). 

 

Why overly optimistic?  I am already hearing anecdotal evidence and rumors that February CPI inflation will be higher, maybe even substantially higher, than January’s 7.1%.  Let us assume that it comes in at 7.0%.  We would need March to come in at 6.5% to bring inflation for the month to 6.9% (if February is 7.5% or 8.0%, March would have to be 6.1% or 5.6%).  Since even the one-off-food-constraint camp believes that it might not be until summer or early fall that food production gets back on line, I don’t think we can expect March CPI numbers to drop so quickly, although they are priced off a higher base.

 

In addition, a friend sent me this today from MarketWatch:

 

Guangdong, China's richest province, said it plans to raise minimum wages by as much as 18% in some cities starting April 1. The decision followed similar actions in other areas, notably the major cities of Shanghai and Beijing. Tibet, an autonomous region administered by China's central government, raised minimum wages by nearly 50% at the beginning of this year. The wage increases, aimed at relieving food and other price pressures, could instead fuel inflation, analysts said. Higher wages are also likely to raise prices of U.S. imports from China, and possibly reduce China's attraction as the world's manufacturing center…

 

Guangdong will increase the province's minimum wages by an average 13% on April 1, the province's labor bureau said in a news release last week. The southern China province produces about 13% of China's economic output, the most among the country's 32 provinces.  Minimum wages in the capital city Guangzhou will rise to 860 yuan ($120) per month from 780 yuan, an increase of 10%. Wages of other cities in the province will also get a boost, with those in some inland cities up nearly 18%.

 

China's other provinces took similar actions earlier this year. Starting Jan. 1, four provinces hiked their average minimum wages by more than 20%, with the increase in Tibet topping the list, according to data collected by Citigroup. Five other provinces increased average wage caps by more than 10%.  Beijing and Shanghai, China's two biggest cities, last year raised their minimum wages to 730 yuan and 840 yuan respectively, in the face of rising consumer prices.  Average minimum wages in China have risen 15% in 2007, Citigroup said in a report, and 21% in 2008 based on available data.

 

If minimum wages are rising, driven by rising food prices, it seems hard to imagine that these increases won’t be priced into factory production.  Some of these wage increases are after the first quarter, so they will not contribute to inflation until much later, but several cities and provinces seemed to have raised the minimum wage early this year or late last year, and I guess we should start seeing the price effect now and into the near future.

 

In line with the announcement by the State Information Center, Han Yongwen, secretary general of the NDRC, is reported to have said in a conference in Suzhou yesterday that China faces “relatively high” inflationary pressure.  From what I gather other senior officials at the conference made similar noises about the need for vigilance, with one of them, Ma Delun, vice governor of the People's Bank of China, adding that China is “confident” that it will be able to tame inflation.

 

In the past few weeks there have been a whole series of statements on inflation worries and the need to maintain vigilance.  I am not sure how to interpret this.  On the one hand it may be evidence that the monetary alarmists have once again regained the upper hand in the policy debate.  On the other it may be because they are worriedly signaling to the NPC, which will be held next week and which will anoint the new senior leadership, including provincial and municipal leaders who traditionally like to begin their time in office by splurging on new investments, that this is not the time to go wild on new projects.

 

One group of players that might welcome a little inflation is the banking sector.  The good news is that last year’s profits have not been reported yet but are expected to surge.  According to an article in the Financial Times, analysts are expecting pre-tax profits to be up 83% in 2007 over 2006 (the 2007 estimate for pre-tax profits is for RMB 610 billion).  For four of the big five (the exception is ABC), ROA went up from 0.88% to 1.11%, a healthy improvement. 

 

On the other hand there is rising concern about real estate loans and declining real estate prices.  Yesterday the CBRC’s vice-chairman Jiang Dingzhi warned bank executives on the CBRC website of the risks of lending to real-estate developers, highly polluting or energy-intensive firms, and other problem sectors, ordering them to step up controls to prevent a rebound in bad loans.  According to today’s South China Morning Post:

 

More than one quarter of the new loans extended by domestic banks in Shanghai last year went to real estate, and by the end of last year the sector accounted for about 32 per cent of their outstanding loans, the 21st Century Herald reported on Thursday. The National Audit Office issued a separate warning that banks were lending too much to finance road construction - their exposure was 800 billion yuan at the end of 2005.  Bad management of some roads and insufficient toll collections meant many banks were finding it hard to recoup their loans, state media said.

 

I have heard it said, often enough that I believe it, that a lot of real estate lending is effectively hidden on the banks’ balance sheets and is not classified as such.  Banking exposure to real estate prices is much greater than the already high exposure levels reported.  As I mentioned in an earlier post, the NPL ratio rose slightly during the last quarter of 2007.  It was only a small increase in a year in which the ratio declined overall, but it occurred during a period rapid economic growth, slowing loan growth, and ample liquidity.

 

THU 28 FEB

Revisiting the one-child policy By Michael Pettis

As a finance guy whose area of interest is financial stability and the impact of short-term adjustments on the economy, I usually don’t spend a lot of time thinking about what might happen in the next few decades, but because of the significant and historically unprecedented demographic imbalances we are seeing in the world today, and especially in China, in spite of myself I have found myself paying attention to demography.  In that light a few weeks ago I began hearing rumors that the Chinese government was seriously considering revising the one-child policy.  Yesterday a number of newspapers around the world carried articles on the topic.  This is what The Times of London had to say:

 

China's political leadership is considering ending the country's hated “one-child” policy because it is damaging the economy and creating a demographic timebomb, a senior minister admitted today.

Zhao Baige, Vice Minister of the National Population and Family Planning Commission, revealed that there is concern at the highest levels that the policy is already tearing apart the fabric of society.

 

"This has become a big issue among decision makers," Ms Zhao told reporters at a routine government press conference in Beijing.  "We want incrementally to have this change. I cannot answer at what time or how."

 

…Ms Zhao suggested that long-term planning on how to bring the policy to at least a partial close may already have begun.  "The attitude is to do the studies, to consider it responsibly and to set it up systematically," she said

 

There have been similar reports in the past about a reconsideration of the one-child policy.  So far nothing much has happened and this may be another case of more of the same – it usually takes a crisis to get the leadership to reverse course dramatically.  Still, as things stand today China has a real demographic problem.  

 

Not only is the population aging at an alarming rate – it is among the most rapidly-aging countries in the world, and the only low-income member in the club of rapidly-aging countries – but it has a serious sex imbalance with about 60-70 million more males than females.  Along with the rate of aging the sex imbalance is also supposed to be a consequence of the one-child policy, although sex imbalances in other Asian countries without birth policies suggest that the reason may be more complex.  As for the rate of aging, I don’t have the numbers in front of me but I think I remember that today just under one in ten Chinese is above the age of 65, whereas in twenty years just over one in four will be.  Please don’t quote me on this because I am relying on my terrible memory for the ratios, but certainly China is aging rapidly.

 

That makes the need to address the one-child policy more urgent than ever.  The members of China’s big baby boom of the 1950s and early 1960s are for the most part still working, but in ten to twenty years they will be moving into retirement, and the number of working age people whose efforts will be needed to support them is not growing nearly as quickly.  To solve the problem China needs more young people. 

 

The problem is that while a relaxation of the one-child policy may be very good for China in the long term, and perhaps even necessary if China is not to suffer a terrible old-age crisis in the next few decades, in the short run it may create even more demographic challenges that may make the authorities less willing than ever to move. 

 

For that reason it is worth considering what the impact of a relaxation of the one-child policy might have in the medium term.  In the long term birth rates would probably decline naturally in China as they have everywhere else.  I read one poll that suggested that most urban Chinese said they wanted to have at most two children, and I think in twenty or thirty years Chinese fertility, even without a one-child policy, would be similar to that of many other urban Asian countries. 

 

But in the short to medium term if the one-child policy were to be relaxed there would almost certainly be a baby boom.  That suggests that for the next 20-25 years China’s dependency ratio, which is already expected to deteriorate dramatically after 2010-2011, will probably get a lot worse before it gets better.  A smaller proportion of China’s population, in other words, would need to produce the goods and services – including expanded health care, education facilities, and a social safety net – needed by a rapidly-growing elderly population and a rapidly-growing population of children.

 

As an aside, my friend Dan Rosen and I have in the past discussed the evolution of China’s trade balance and foreign currency reserve position, and Dan has argued, and I agree, that one consequence of China’s aging population may be future pressure on the trade account.  It may not be irrational, in other words, for China to accumulate such a huge stockpile of foreign exchange reserves because for some period in the future China may be forced to pay for demographic adjustments and finance a trade deficit by liquidating foreign holdings. If China were to experience a baby boom in the near term the pressure would be even greater.