My Blog

April 14, 2008

MON 14 APR

Have we begun the countdown to the maxi-revaluation? By Michael Pettis

Today’s China Daily reports a speech made over the weekend by a senior central bank advisor at the Boao Forum for Asia, in Hainan.  According to the article, Fan Gang, a member of the central bank's monetary policy committee and someone whose concern about hot money has often been cited in this blog, said China should remain wary of hot money inflows.  “China is seeing an even stronger capital inflow now, despite some nations suffering a credit crunch,” he said. 

 

A perhaps franker assessment was then provided by Zhu Baoliang, vice president of State Information Center, a research institution under the National Development and Reform Commission.  According to a China Daily article referencing the official Shanghai Securities News:

 

“More than $80 billion in hot money came into China in the first quarter, compared to the total hot money inflow for the whole of 2007 of around $120 billion and an average monthly amount of $10 billion (last year). So this year's hot money volume is three times last year's,” Zhu was quoted as saying.

 

The inflows in the first quarter have increased market liquidity, which in turn could put further upward pressure on inflation, he warned.  Because of this, the Chinese government must be cautious in allowing faster yuan appreciation, he said. While faster currency appreciation will help ease domestic inflation by dampening the price of imports, it will also cause higher hot money inflows speculating on the currency's rise.

 

In Saturday’s entry I tried to figure out what is happening to the hot money proxy as far as the most recent reserve numbers go, and although it is not always easy to understand given the opacity of the PBoC’s accounts and the various did-they-or-didn’t-they moves that may have affected the headline numbers, I think that the evidence is pretty strong that hot money inflows are coming in fast and furious.

 

I don’t know if Mr. Zhu’s $80 billion is correct – no one can really say how much hot money there is because most of it is necessarily hidden – but I am intrigued that whatever proxy he uses suggests that hot money inflows have tripled compared to last year.  That certainly fits in with my own intuition.

 

The existence and size of hot money inflows is not just a debate about monetary growth.  I believe it is the key determinant as to whether or not the PBoC will continue the current appreciation path or be forced into a maxi-revaluation.  Rapid but gradual appreciation of the currency will actually worsen the country’s financial imbalances if they cause such an upsurge in monetary inflows that the PBoC becomes totally helpless in controlling monetary growth.

 

Since the only effective way to stop these inflows would be to eliminate the cause of the inflows – the expectation of appreciation – if these inflows are so huge so as to be seriously destabilizing the PBoC will have to make the one-off jump that brings the currency into at least temporary balance.  The problem is that the longer they wait, the more monetary problems they store up and the more difficult the adjustment.

 

It is interesting that there seem to be a lot of comments circling around this point.  According to Mr. Zhu “Allowing the yuan to appreciate rapidly in a short period of time and then holding it stable would be very useful to restrain hot money.”  He also argued, according to China Daily, that the opportunity for using yuan appreciation to fight inflation will exist in China only in the first half of this year.

 

I am not sure what he means by the opportunity only existing in the first half of the year, but it is interesting that he favors a rapid appreciation followed by a peg, which is also my own favorite policy choice.  The difference between us, and it might not be a difference at all, depends on what he means by “appreciate rapidly in a short period of time.”  Certainly a maxi-revaluation could be included under that phrase.

 

On the other hand Zhou Xiaochuan, the PBoC’s governor, said from Washington yesterday that the PBoC still has room to raise interest rates rather than rely exclusively on RMB appreciation.  According to Bloomberg,

 

“China will do things according to our own economic situation,” as the nation isn't “highly dependent”' on the exchange rate for reaching the inflation target, Zhou said. “The anti-inflation policy is a combination of both quantitative measures and price measures.”

 

Don’t expect too much more appreciation, he seems to be saying, since we still have other tools with which to fight inflation.  I guess he has to say that, but I wonder if he is as worried as I think he should be. 

 

Meanwhile Liu Shiyu, the deputy governor of the People's Bank of China, said in Shanghai over the weekend something that I guess we already knew: CPI inflation for March, although not to be formally released until Thursday, is going to come in at 8.3%.  This means that annualized inflation for the first quarter of the year is 13%.   

 

I think this is just the beginning of a longer inflationary period in which declining food prices will be matched by rising non-food prices, as explained in my April 4 entry, but to be fair there are still a lot of economists, and still a majority, who disagree.  For example according to Shen Minggao, an economist at Citibank:  “Consumer inflation probably stayed high in March on costly food while non-food prices picked up pace. We continue to believe that the estimated 8 percent CPI rate in the first quarter will mark the peak of inflation this year.”  We’ll see.  A lot of bank economists are arguing that March, or perhaps April, will mark the inflationary peak, but I have to say I am very, very skeptical.  This is going to continue much longer, especially as hot money inflows have gotten much worse.

 

By the way I saw an interesting piece about the problem of surging rice prices in today’s Financial Times.  The article said that according to the Asian Development Bank food accounts for 40% of the Chinese consumption basket.  The National Bureau of Statistics of China reportedly has food comprising just over 33% of the CPI basket.  My quick-and-dirty calculation suggests that if we adjust the food component upward inflation is actually substantially higher than reported.  For example in March it wouldn’t be 8.3% – it would be closer to 9.6%.