My Blog

March 21, 2008

FRI 21 MAR

How do you turn this thing off? By Michael Pettis

According to Market News International Chinese foreign exchange reserves hit $1.6471
trillion at the end of February.  This means that foreign exchange reserves rose by a surprising $57.3 billion over the month of February (actually I am lying – none of these numbers surprise me anymore).

 

In January reserves were up officially by nearly $62 billion, although there are strong reasons to believe that the headline number was understated by $22 billion – the amount of the hike in the minimum reserve requirement, which the banks were probably asked to redenominate in US dollars.  For the first two months of the year, then, reserves are up by $119 billion (and in terms of monetary impact they were probably up $141 billion), which far outpaces the already outlandish $40-50 billion monthly increase on average during the 2007.  

 

The trade surplus contributed $25 billion and FDI contributed $11 billion to reserve growth in January.  In February they contributed only $8.6 billion and $6.9 billion, respectively.  So even with sharply lower contributions from trade and FDI ($16 billion versus January’s $36 billion), reserve growth in February has been extremely high.  Let’s assume that valuation mark-ups and interest income added around $10 billion.  That still leaves us with over $30 billion to explain.  It can’t all be hot money, of course, but all the circumstantial evidence seems to suggest that hot money is accelerating.  No big surprise, perhaps, given the pace of RMB acceleration.

 

I am not sure what exactly is going on to account for all this inflow, but it seems that with reserve growth accelerating, and with it the monetary expansion that occurs as the PBoC is forced to buy the reserves, it is going to be almost impossible to rein in the overheating and inflation that plague the economy.  I am afraid that for all the talk and action, things are getting worse, not better.

 

If this level of reserve growth adversely impacts the fight against inflation, which I expect it will, a recent PBoC survey bodes ill.  A 50-city quarterly survey conducted by the PBOC found that in the first quarter, 49.2% of the 20,000 respondents said prices had become “intolerable”.  According to the results, released yesterday, the proportion was a record high, up from 25.9% in the first quarter of 2007.  

 

In an article on the PBoC survey, the China Daily reported:

 

There is some positive news on inflation, however. The survey found that just 49 percent of people expect inflation to rise in the second quarter of the year, down from 65 percent who thought so in the previous survey.  The results show the public has confidence in the country's efforts to stabilize prices, the central bank said.

 

I am not sure this is necessarily all good news.  This public confidence is a good thing if it restrains inflationary expectations, but I am afraid that if the public is confident that the authorities can indeed control inflation, they are likely to be all the less prepared and more disappointed if the authorities fail, and in my opinion this level of reserve growth makes me more skeptical than ever that inflation can be controlled.

 

Meanwhile the administrative fight against inflation is still raging.  According to today’s Xinhua:

 

Supervision departments were urged on Thursday to crack down on market speculation and illegal price hikes to ensure smooth market order. A circular from the Ministry of Supervision asked its local bureaus nationwide to step up inspections to ensure that the central government's price policy was fully implemented. It called for severe punishment of illegal activities including price-fixing, hoarding, cornering markets and spreading price-rise rumors to make profits.

 

The ministry also urged local offices to strengthen monitoring of the implementation of energy conservation and emission reduction regulations and punish violators.  Implementation of the central government's policies on fixed-asset investment and real-estate market development would also be checked and violators would be penalized, according to the document.

 

And as long as we are on the subject of capital inflows, the World Bank released an interesting study on global workers’ remittances yesterday.  According to the study:

 

The top five recipients of migrant remittances in 2007 were India ($27 billion), China ($25.7 billion), Mexico ($25 billion), the Philippines ($17 billion), and France ($12.5 billion).

 

At least now we can explain another $2 billion or so per month in capital inflows.