By Chan Akya
Reality is often stranger than fiction. It is only much more so in financial matters. Who would have thought at the beginning of this year that a few deadbeats driving trucks in Arizona would spark the greatest financial crisis in recent history, aided and abetted by the very regulators who are (over) paid to stop such things from every happening? And that their actions would have consequences enough to dethrone many a Wall Street head and their lackeys, as well as threaten a multitude of regulators and in future, governments too? That the attempts at keeping these truckers in good financial health would unleash inflation across Asia and in turn threaten further economic calamities in the near future?
Given the unprecedented nature of recent events, it is necessary to invent a new word, which captures the emotive, urgent and contagious nature of the new disease at the heart of the global financial system, and for those reasons, I hereby coin the term "financialitis" to mean the unexpected and wide-ranging blow up of a country's financial system. The US, Germany and the UK have seen mild forms of Financialitis this year and yet are nowhere near a recovery point.
In an article earlier this year (Hobson's choice Asia Times Online, March 10, 2007), well before the onset of financialitis, I wrote about the inter-dependency between the US financial system and Asian savers that leads the latter to bail out the former and in turn heap on themselves the adverse results of financial losses as well as inflation. Over a period of time, the value of the assets being purchased by Asian central and commercial banks turned rather suspect indeed, leading to billions in investment losses ( The robbery of the century Asia Times Online, July 14, 2007). Interestingly, this led to a Hong Kong-based bank being downgraded earlier this month as rating agencies discovered material exposure to US assets in a lender that really shouldn't have had any based on its geography and expertise. That is just the one bank that got caught. I have no doubt that many others will slowly reveal the extent of their investment losses in months to come.
That opinion on the prevailing equilibrium, ie that Asians would quietly absorb losses and play for longer-term benefits accorded by keeping the American consumer above water, was soon shaken by the onset of jitters between major global banks, which refused to lend to each other (In gold we trust Asia Times Online, September 8, 2007). This proved the undoing of asset valuations, in turn pushing bank-borrowing costs through the roof, and in one extreme case sparking a bank run in the UK (Rocking the land of Poppins Asia Times Online, September 22, 2007). Despite a number of attempts to quell the costs of borrowing, such as ill-timed interest rate cuts by the US and UK central banks as well as freeing up of "discount-rate" borrowings over the counter, the crisis persists till today, with year-end financing still proving quite dear for many banks across the world.
SUVs, SIVs and SWFs
The effects of an over-consuming America on the world are best typified by the country's reliance on an outmoded transport system that places excessive emphasis on individuality at the expense of optimality. The emblematic vehicle is of course the SUV, which is neither sports nor utility and is perhaps responsible in large part for America's addiction to oil. Then again, the nature of US polity is such that its not the addict but rather the supplier who faces the stick ('Cracks' in credit Asia Times Online, August 25, 2007) and much the same has unfolded in the world of finance over the course of this year.
US officials, led by the Treasury secretary, have been busy trying to push through cosmetic improvements to financial assets, as shown by the Super-SIV program that has come to represent everything that is wrong with the US. SIVs, or special investment vehicles, are usually owned by banks or other "respectable" financial institutions and designed to gather funds at costs similar to that of banks from the wholesale market, mainly from vehicles called money-market funds. These funds in turn get deposits from the general public, who invest on the assumption that returns are slightly higher than what is available on bank deposits.
The SIVs in turn invest in illiquid assets that represent the toxic waste thrown out by US banks but are packaged to look more respectable than they actually are by the sleight of credit ratings provided by the very people who help design the investments (this is the point where readers should be saying "nice job if you can get it"). The reasons for this circuitous way of investing in dangerous assets is to create enough margins for all parties involved while providing legal protection to malignant financial engineers. US political observers term this "plausible deniability" and what it really means is that once a few sacrificial lambs have been offered up (Off with their heads Asia Times Online, November 6, 2007), ways will be found to resume business as usual.
Anyway, all these plans depended on the SIVs continuing to fund themselves in the market, which unfortunately was not to happen once summer doldrums hit the US and European financial systems. Soon enough, banks had to absorb the SIVs, which is the same as buying back exactly all the dangerous bombs you thought had been removed from your bunker last week, with the added problem that someone had probably removed a few fuses on the devices along the way out and back - as in because of the problems of the SIVs, it was no longer a secret that some of the assets held by these vehicles were toxic and probably worth a lot less than what they were bought for, and now that the sponsoring banks were consolidating the SIVs into their own balance sheets, they had to absorb such losses directly.
With that eventuality, major US and European banks had to announce revised loss expectations, and to make matters worse, also come clean on a whole host of other assets that were not even in trouble during the summer, such as corporate loans issued for purchasing other companies (so-called LBO facilities). All told, there are some estimated US$100 billion in new losses for just the major banks from various lines of activity, which at the conservative price earnings multiple of 10 times, would mean that a trillion or so dollars has been wiped out of the stock market valuations. Just the top three US commercial banks have lost over $150 billion in market value this year, while the top three investment banks have done better due mainly to the performance of one firm (Goldman Sachs), without which they are also down about $100 billion. In Europe, we are probably looking at over a quarter of a trillion US dollars in market capitalization wiped out, and that is before any financial crisis has hit the Europeans.
The UK has seen two consecutive months of property price declines already, and other European economies such as Spain and France are witnessing similar drops in their domestic property since the third quarter of this year. It seems only a matter of time before the Europeans catch the American disease of falling property prices, which will likely push their financial system into a deep crisis next year.
This is where the sovereign wealth funds (SWFs) have come into the picture. With share prices falling across the global financial system, the US and other governments have been "requesting" some degree of assistance from these funds, aimed at shoring up confidence in their financial system. This is what I predicted in Cracks in credit (see above), but it has happened even sooner than I expected - which of course means that the crisis in the US and European banking system is worse than what we have seen so far. This is of course delicious irony, as these very SWFs were targeted for stern lectures just in October this year (Dear dinosaurs Asia Times Online, October 20, 2007).
The SWFs will fail in their efforts to shore up investor confidence in US and European banks. Their share prices will decline further as more problems are discovered and global investors realize that the basic business model of many of these banks has been irreparably broken this year. Many will not survive in their current forms, necessitating costly (ie shareholder-dilutive) mergers. Then again, SWFs are usually in countries with poor or zero accountability to the general population - such as Singapore, China and the Middle East. Therefore, they will get away unscathed from such losses.
Asian impact
By and large, none of the above should matter to the average Asian borrower or saver. I mean, why exactly does a manufacturer in Fujian province need to care about the problems confronting bankrupt homeowners in California? In the old days, that logic would indeed hold but unfortunately it does not any more.
It is indeed true that any manufacturer or service provider in Asia can get enough funding from his local banks, but only so far as some conditions such as final maturity and currency are met. This is a problem for many manufacturers who attempt to create a natural hedge between their revenues and liabilities. Thus, an exporter who receives payment in US dollars would hate to see his liabilities denominated in Chinese yuan, as they keep increasing in value even as his income from selling widgets in the US declines.
To get a US dollar-denominated loan though, he must pay up similar to what a similar manufacturer in another country like Germany or Mexico or even the US would need to pay. This comparative cost is now enhanced by the credit crisis in the US and European financial systems.
The second path of impact for Asian borrowers is that as their local banks lose billions on the US financial system, their natural tendency to tighten up standards would likely cause hardships to the average borrower, either through lower credit limits or higher cost of borrowings. Asian banks, unlike their US and European counterparts, tend not to distribute their risk, which means the impact of localized losses can be quite high, in turn triggering a tightening in credit conditions.
Thirdly, it is now inevitable that Asian countries will loosen or abandon their pegs to the US dollar over the course of 2008. Their battle with inflation lost comprehensively, (Inflation - China's lost battle Asia Times Online, December 15, 2007) governments around the region have no choice but to get more aggressive on their monetary conditions, which cannot be accomplished when their currencies remain pegged to the US dollar.
When this happens, it is highly possible that even profitable exporters of goods and services in Asia will have to confront a crisis of confidence from lenders, who will fret about their ability to survive when the local currency gains sharply against the US dollar. This process of creative destruction is central to re-jigging Asian economies away from production towards consumption, but it will be painful nevertheless.
Welcome then, to the New Year, when the broken parts of the world will remain broken, while those that haven't yet succumbed will slowly get sucked into the maelstrom. Asians will come out of the New Year, ie approach 2009, stronger and more important than ever before, but there will be many a week and month in the interim when it certainly won't feel anything like it.
Saturday, December 22, 2007
China wages a cool war
By Olivia Chung
HONG KONG - The Chinese government, which spent 2007 trying to prevent the country's economy overheating, caught investors on the hop this week with the sixth interest rate rise of the year, adding to indications that it will intensify its efforts to cool the economy in the coming 12 months.
With effect from December 21, the one-year deposit rate was raised by 27 basis points to 4.14% , while the one-year lending rate was raised by 18 basis points to a nine-year high of 7.47%. These and other interest rate adjustments came as a surprise as previous rate increases were revealed on Fridays after the stock markets had closed or during weekends.
In another move to encourage depositors to keep their money in banks and not invest them in stock and the property markets, the People's Bank of China, the central bank, lowered the rate paid on money held in current accounts to 0.72% from 0.81%. A PBoC spokesperson said that the move was meant to encourage depositors to put their money in fixed deposits instead of current accounts, so that more money will stay in banks longer, instead of flowing into the asset markets.
The government's action followed the PBoC announcement on December 8 of the 10th and the largest increase in the reserve requirement ratio for banks this year, possibly presaging more aggressive macro-economic controls in the coming year.
With the latest 1% rise, the reserve requirement ratio for commercial banks reached a record high of 14.5%. That is, for every 100 yuan deposit they receive, they now have to put aside 14.5 yuan (US$13.50)in reserve, limiting the scope for lending. The central bank has raised the ratio nine times this year, the latest being a more aggressive rise than the 0.5 percentage point increases on previous occasions.
Jun Ma, chief economist of Greater China Head of China/Hong Kong Macro Strategy at Deutsche Bank Hong Kong, said in a research note after the announcement of the latest rate changes: "We think the PBoC will raise rates by one or two more times in the first half of next year, and will be on hold in the second half of next year, as inflation is likely to remain at or above 5% in the coming months but will likely fall towards to 4% or below in the second half of next year.
"The cumulative rate increases in 2008 [by up to 54 basis points for the one-year deposit rate] is likely to be much more modest than in 2007 [162bps]," he said.
The December 8 increase in the reserve requirement was in line with the policy principles set this month by the Central Economic Work Conference to tighten monetary policy in 2008 to curb "excessive liquidity" in the economy, or too much money in the market and people's pockets. The conference, convened at the end of each year to set policies for the coming 12 months, was attended by all members of the Politburo Standing Committee and senior party and government officials overseeing the country's economic affairs.
The conference set two main goals for 2008: to prevent the economy from overheating while keeping relatively high-speed growth, and to prevent structural prices rises from becoming entrenched inflation. The meeting pledged to shift its monetary policy from "prudent" - an approach it has followed for the past 10 years - to "tight", while continuing a prudent fiscal policy.
To attain the goals, China will act to curb money supply to curb investment and inflation while increasing government spending to boost domestic consumption, seeking to ensure the economy will not have a hard landing.
Therefore, while the central bank tightens the belt, the National Development and Reform Commission (NDRC), the country's top economic planning body, pledged that the government will increase its overall investment budget and continue to adjust investment structures.
NRDC head Ma Kai said after the Central Economic Work Conference that, following the "continuous and rapid" increase in tax and other revenues in recent years, China will mainly use its fiscal spending to improve people's livelihood and boost economic and social development in weak and backward areas. He didn't disclose specific figures for 2008, noting that the financial ministry is working at the budget.
China's fiscal revenue may expand by 27.23% to more than five trillion yuan this year, compared with 3.93 trillion yuan in 2006, according to Yao Jingyuan, chief economist with the National Bureau of Statistics. The forecast is lower than the 31.4% growth rate in the first three quarters, although Jia Kang, director of the Research Institute for Fiscal Science, under the Ministry of Finance, said earlier this month that this year's revenue might reach 5.1 trillion yuan, up 31% over last year.
The budget for government spending for 2007 reached 2.69 trillion yuan, up 14.4% year on year. Although the spending figures are lower than the indicated revenue, the government runs a deficit, which it has said will narrow to 245 billion yuan this year from 295 billion yuan in 2006.
Analysts say Ma Kai's remarks suggest the Chinese government will continue to have a budget deficit even as it increases its spending on social welfare, public health, education and other public services in addition to infrastructure projects.
Chen Jiagui, deputy dean of the Chinese Academy of Social Sciences (CASS), a top mainland think-tank, said at a press conference in early December that the economy was overheated, judging from the increase in fixed-asset investments, exports, consumer goods prices and housing prices as well as share prices.
"The economy has been in the fast lane, so it's not easy to slow down. Soaring food prices are spreading to other sectors. The pressure of serious inflation is accumulating," Chen said.
The latest and higher-than-usual rise in banks' deposit reserve ratio, expected to take about 400 billion yuan out of the banking system, indicates China will introduce more stringent policies to curb excessive bank lending, which starts usually at the beginning of a new year, Guo Tianyong, economist with the Central University of Finance and Economics, said.
China's economy is set to complete its fifth consecutive year of double-digit growth. CASS recently revised up to 11.6% its forecast for this year's gross domestic product expansion, from its forecast of 10.6% made in April. It also raised its prediction of consumer price index (CPI) growth for 2007, to 4.5% from 2.7%. The country's trade surplus would continue to expand next year, to $290 billion from this year's estimated $260 billion, the academy said.
China's trade surplus with the world for the first 11 months of this year hit $238 billion, far surpassing the $177.5 billion recorded for the whole of 2006. Even so, following government measures to adjust the country's trade balance, such as reducing or canceling export rebates for some products, the academy has adjusted earlier trade forecasts to show a pick-up in import growth and slowing rate of export growth.
CASS forecast that import growth rose in 2007 to 22.9% from 20.3% and export growth slowed to 20.5% from 25.1%. Last month, exports rose 22.8% year-on-year to $117.62 billion last month, while imports rose 25.3%, to $91.34 billion, bringing the trade surplus that month to $26.3 billion in November, compared with $27.05 billion in October.
CASS suggested that to further rein in economic growth the central government reduce fixed-asset investments - which it expects to rise 25.6% this year and 24.2% next year. Chen said the government may find it difficult to effectively implement a tight monetary policy as local authorities are reluctant to comply with instructions from the power center.
The swelling trade surplus helped the broadest measure of money supply, M2, including cash and all deposits, to increase 18.45% year on year to 39.98 trillion yuan in November, and the 10th straight month it has breached the central bank's annual target of 16%.
The increasing liquidity has led to fast investment growth and exacerbated price rises. In November, the CPI rose 6.9%. That is more than double the government's inflation target of 3% and is the biggest increase since 1996. Food prices, accounting for one-third of China's CPI, ballooned 18.2% year-on-year in November, compared with 17.6% in October.
Pork prices led the food price gains with a 56% increase, amid a supply shortage triggered by a pig cull following the outbreak of blue-ear disease. Local governments have been increasing subsidies for pig farmers to boost their profit margins and hopefully to lift the amount of pork available in the market. The NDRC forecast that the impact of the measures would be noticeable in the market from the second half of next year.
As they reel from rising cost of commodities including edible oil and vegetables, Chinese have also had to contend with an unstable supply of fuel. A diesel shortage was reported throughout China, from eastern Shanghai to southern Guangdong province and central Henan province to Beijing, with long queues seen at many gas stations. Retail fuel prices were raised by up to 10% from November 1, adding to the operating costs of train and bus companies.
To curb inflation, the central bank has raised the one-year benchmark interest rate paid on bank deposits to encourage savings. It has also cut to 5% the previous 20% tax on interest earned in savings deposits. Even so, growing inflation prompts some economists to argue that there is still room for interest rate increase.
"We think there will likely be 150-200 basis points [bp] additional increases in the reserve requirement ratio, further selling or issuance of special Ministry of Finance bonds and PBoC bills, one to two more rate hikes within the coming three to five months, and a slight acceleration of yuan appreciation to 6 to 7% versus the US dollar next year," Deutsche Bank's Jun Ma said in a research note on December 12.
In his note on the most recent rate changes, Ma wrote: "November CPI inflation reached a new high of 6.9% year-on-year, raising the urgency to contain inflation expectations." Larger increases for three-month and six-month deposit rates "were clearly attempts to discourage depositors from moving funds out of the banking system [due to higher inflation expectations].''
The PBoC changes effective December 21 included increases of 45 basis points in the three-month term deposit rate and a 36 basis point rise in the six-month rate.
"Although the reserve ratio requirement [RRR] was raised by a more aggressive one percentage point recently, it could be partly explained by the specific need to sterilize the liquidity injection from large sums of maturing PBoC bills and forthcoming withdrawal of significant fiscal deposits by year-end. Therefore, the RRR increase would not be a perfect substitute for the rate hike," he wrote.
Yi Xianrong, an economist with CASS, earlier said expected the central bank to increase interest rates soon, since negative real interest rates had created an excessive credit and asset bubble.
Despite the country's measures to rein in the real-estate boom, including tightening credit to developers and increasing supervision on land use, the country's larger cities have all reported rapid growth in housing prices this year. According to the NDRC, average housing price in the mainland's 70 large and medium-sized cities jumped 10.5% year-in-year in November compared with October's 9.5% growth rate and September's 8.9%, fueled by robust investment and demand. Investment in the real-estate market jumped 31.8% in the first 11 months of this year from 2006 to 2.16 trillion yuan, the NDRC reported.
Investment in the real-estate market jumped 31.4% in the first 10 months of this year from 2006 to 1.92 trillion yuan, the National Bureau of Statistics reported. About 1.37 trillion yuan was invested in residential property in the first 10 months, rising 33.7% from the same period last year.
Clement Luk, director and assistant general manager at Centaline (China) Property Consultant's Shanghai office, believed second-tier cities will remain the focus for property investors for 2008, due to higher profit margin.
"Since some second-tier cities such as Tianjin and Chengdu have been well explored, some property developers have shifted their focus to third-tier locations such as Zhuhai, Weizhou and Dongguan," he said. Luk expected more tightening policies, including increases in interest rates and mortgage deposits. The central bank and the China Banking Regulatory Commission on September 27 raised mortgage deposits to 40% for second homes.
Stock volatility
With limited investment channels in China other than the property sector, the stock market has become the most favored target to boost income over the past year, China's stock market, which gained 130% in 2006, continued to surge in the first 10 months of this year, with the Shanghai Composite Index hitting a record high of 6,124 on October 16.
The number of new A-share stock accounts opened daily reached about 350,000 at their peak in April. As the country's stock markets became more volatile in the second half, the number of new accounts opened per day dropped significantly, falling to 122,000 in the last week of November, 37% down on the previous month.
Hu Weitao, chief investment officer of Valuefinder Investment Management Co in Shenzhen, expected the market downturn seen since last October to continue amid possible tightening monetary policy and sagging investment confidence.
The mainland stocks markets have gained about 88% this year, but concerns among mainland authorities that a bubble had developed eased with a contraction of about 20% from record highs set in October.
In a December 11 China Strategy research note, Morgan Stanley economist Jerry Lou ruled out a bubble scenario for Chinese equities, following the investment house's US economist's call for a mild recession in the coming year and seemingly aggressive tightening efforts by the PBoC.
Lou remained bullish on HK-listed offshore China equities in 2008. "We think corporate China can handle the three challenges including: 1) a US recession and export slowdown; 2) domestic asset price deflation; 3) monetary tightening and austerity controls, well through 2008."
The Hong Kong stock market is becoming increasingly Sinicized and more sensitive to central government actions as more funds, legal and illegal, enter Hong Kong from China and a significant number of mainland companies list in the former British territory.
Even as international funds cashed out, Hong Kong's benchmark Hang Seng Index gained 33% this year to mid-December, helped by the central government announcement in late summer that it planned to allow individual mainland investors to purchase Hong Kong equities. When Premier Wen Jiabao later said the "through train" plan might be delayed, the index retreated 5.01% on November 5 to close at 28,942.32, the biggest fall since the September 11, 2001, terrorist attacks.
This increasing sensitivity to mainland events is raising concern among some investors that the Hong Kong market in the coming year will fluctuate like its more volatile mainland counterparts, particularly in relation to government measures.
"It's getting obvious that the Hang Seng Index is driven up by mainland enterprises," said Conita Hung, head of equity markets at Delta Asia Financials. "Given the more volatile nature of the H-share index, the local stock market benchmark is likely to experience large fluctuations," she said. H-share companies are Hong Kong-listed enterprises incorporated in the mainland and with their main businesses based there.
As the central government tries to come to grips with worsening inflation and increasing trade surpluses, some analysts argue that a quicker appreciation of the yuan would help on both counts, while others contend that a sudden rise in the Chinese currency's value compared with the US dollar would not serve the interests of either China or the US.
A fast appreciation of the yuan would mean that "China will lose its competitiveness as the factory of the world, which will cost China its bargaining power with developed countries on product prices", Zhang Tingbin, deputy chief editor of China Business News, said in a recent column. "Faced with the subprime mortgage crisis, the most important task for the US government is to try to maintain the stability of the macro environment and of the exchange rate of dollars."
It is almost certain that the Chinese government will continue its gradualist approach toward yuan revaluation, recognizing that a quick change in the country's exchange rate would hurt the country's export-oriented manufacturing industries, putting the jobs of millions of workers at risk.
However, as PBoC governor Zhou Xiaochuan said recently, China may allow the yuan to float in a more flexible range, suggesting the government may expand the trading range in the new year. The yuan closed at 7.3797 to the US dollar on December 11, on the eve of the third round of the Sino-US Strategic Economic Dialogue in Beijing, a high since its revaluation in the summer of 2005. The currency has strengthened about 5.5% this year.
As the Chinese economy continues to grow strongly, the potential impact of a possible recession in the US looms large. Zhou Zhenhua, director of the Shanghai municipal people's government development research center, said the impact of the US subprime mortgage crisis will gradually be felt through to 2010.
"The impact of the subprime mortgage crisis will spread to the developed countries like those in the European Union and weaken their economies, which eventually will slow down China's export market," he said.
Fan Gang, a member of the central bank's monetary policy committee, however, said losses from a probable decelerating US economy could be offset by gains from European countries and Japan. "Past experience shows that a slowdown of the US economy will lead to a fall in China's exports to the US. In fact, in the past five years, China's exports to the US have been on the decline [in relative terms], so we think the probable US recession will have a smaller impact than we had expected," he said.
Fan also objected to the idea of a quick appreciation in the yuan, saying it would trigger large speculative capital inflows and outflows that would harm China's economic growth and financial stability.
Olivia Chung is a senior Asia times Online reporter.
(Copyright 2007 Asia Times Online Ltd. All rights reserved. )
HONG KONG - The Chinese government, which spent 2007 trying to prevent the country's economy overheating, caught investors on the hop this week with the sixth interest rate rise of the year, adding to indications that it will intensify its efforts to cool the economy in the coming 12 months.
With effect from December 21, the one-year deposit rate was raised by 27 basis points to 4.14% , while the one-year lending rate was raised by 18 basis points to a nine-year high of 7.47%. These and other interest rate adjustments came as a surprise as previous rate increases were revealed on Fridays after the stock markets had closed or during weekends.
In another move to encourage depositors to keep their money in banks and not invest them in stock and the property markets, the People's Bank of China, the central bank, lowered the rate paid on money held in current accounts to 0.72% from 0.81%. A PBoC spokesperson said that the move was meant to encourage depositors to put their money in fixed deposits instead of current accounts, so that more money will stay in banks longer, instead of flowing into the asset markets.
The government's action followed the PBoC announcement on December 8 of the 10th and the largest increase in the reserve requirement ratio for banks this year, possibly presaging more aggressive macro-economic controls in the coming year.
With the latest 1% rise, the reserve requirement ratio for commercial banks reached a record high of 14.5%. That is, for every 100 yuan deposit they receive, they now have to put aside 14.5 yuan (US$13.50)in reserve, limiting the scope for lending. The central bank has raised the ratio nine times this year, the latest being a more aggressive rise than the 0.5 percentage point increases on previous occasions.
Jun Ma, chief economist of Greater China Head of China/Hong Kong Macro Strategy at Deutsche Bank Hong Kong, said in a research note after the announcement of the latest rate changes: "We think the PBoC will raise rates by one or two more times in the first half of next year, and will be on hold in the second half of next year, as inflation is likely to remain at or above 5% in the coming months but will likely fall towards to 4% or below in the second half of next year.
"The cumulative rate increases in 2008 [by up to 54 basis points for the one-year deposit rate] is likely to be much more modest than in 2007 [162bps]," he said.
The December 8 increase in the reserve requirement was in line with the policy principles set this month by the Central Economic Work Conference to tighten monetary policy in 2008 to curb "excessive liquidity" in the economy, or too much money in the market and people's pockets. The conference, convened at the end of each year to set policies for the coming 12 months, was attended by all members of the Politburo Standing Committee and senior party and government officials overseeing the country's economic affairs.
The conference set two main goals for 2008: to prevent the economy from overheating while keeping relatively high-speed growth, and to prevent structural prices rises from becoming entrenched inflation. The meeting pledged to shift its monetary policy from "prudent" - an approach it has followed for the past 10 years - to "tight", while continuing a prudent fiscal policy.
To attain the goals, China will act to curb money supply to curb investment and inflation while increasing government spending to boost domestic consumption, seeking to ensure the economy will not have a hard landing.
Therefore, while the central bank tightens the belt, the National Development and Reform Commission (NDRC), the country's top economic planning body, pledged that the government will increase its overall investment budget and continue to adjust investment structures.
NRDC head Ma Kai said after the Central Economic Work Conference that, following the "continuous and rapid" increase in tax and other revenues in recent years, China will mainly use its fiscal spending to improve people's livelihood and boost economic and social development in weak and backward areas. He didn't disclose specific figures for 2008, noting that the financial ministry is working at the budget.
China's fiscal revenue may expand by 27.23% to more than five trillion yuan this year, compared with 3.93 trillion yuan in 2006, according to Yao Jingyuan, chief economist with the National Bureau of Statistics. The forecast is lower than the 31.4% growth rate in the first three quarters, although Jia Kang, director of the Research Institute for Fiscal Science, under the Ministry of Finance, said earlier this month that this year's revenue might reach 5.1 trillion yuan, up 31% over last year.
The budget for government spending for 2007 reached 2.69 trillion yuan, up 14.4% year on year. Although the spending figures are lower than the indicated revenue, the government runs a deficit, which it has said will narrow to 245 billion yuan this year from 295 billion yuan in 2006.
Analysts say Ma Kai's remarks suggest the Chinese government will continue to have a budget deficit even as it increases its spending on social welfare, public health, education and other public services in addition to infrastructure projects.
Chen Jiagui, deputy dean of the Chinese Academy of Social Sciences (CASS), a top mainland think-tank, said at a press conference in early December that the economy was overheated, judging from the increase in fixed-asset investments, exports, consumer goods prices and housing prices as well as share prices.
"The economy has been in the fast lane, so it's not easy to slow down. Soaring food prices are spreading to other sectors. The pressure of serious inflation is accumulating," Chen said.
The latest and higher-than-usual rise in banks' deposit reserve ratio, expected to take about 400 billion yuan out of the banking system, indicates China will introduce more stringent policies to curb excessive bank lending, which starts usually at the beginning of a new year, Guo Tianyong, economist with the Central University of Finance and Economics, said.
China's economy is set to complete its fifth consecutive year of double-digit growth. CASS recently revised up to 11.6% its forecast for this year's gross domestic product expansion, from its forecast of 10.6% made in April. It also raised its prediction of consumer price index (CPI) growth for 2007, to 4.5% from 2.7%. The country's trade surplus would continue to expand next year, to $290 billion from this year's estimated $260 billion, the academy said.
China's trade surplus with the world for the first 11 months of this year hit $238 billion, far surpassing the $177.5 billion recorded for the whole of 2006. Even so, following government measures to adjust the country's trade balance, such as reducing or canceling export rebates for some products, the academy has adjusted earlier trade forecasts to show a pick-up in import growth and slowing rate of export growth.
CASS forecast that import growth rose in 2007 to 22.9% from 20.3% and export growth slowed to 20.5% from 25.1%. Last month, exports rose 22.8% year-on-year to $117.62 billion last month, while imports rose 25.3%, to $91.34 billion, bringing the trade surplus that month to $26.3 billion in November, compared with $27.05 billion in October.
CASS suggested that to further rein in economic growth the central government reduce fixed-asset investments - which it expects to rise 25.6% this year and 24.2% next year. Chen said the government may find it difficult to effectively implement a tight monetary policy as local authorities are reluctant to comply with instructions from the power center.
The swelling trade surplus helped the broadest measure of money supply, M2, including cash and all deposits, to increase 18.45% year on year to 39.98 trillion yuan in November, and the 10th straight month it has breached the central bank's annual target of 16%.
The increasing liquidity has led to fast investment growth and exacerbated price rises. In November, the CPI rose 6.9%. That is more than double the government's inflation target of 3% and is the biggest increase since 1996. Food prices, accounting for one-third of China's CPI, ballooned 18.2% year-on-year in November, compared with 17.6% in October.
Pork prices led the food price gains with a 56% increase, amid a supply shortage triggered by a pig cull following the outbreak of blue-ear disease. Local governments have been increasing subsidies for pig farmers to boost their profit margins and hopefully to lift the amount of pork available in the market. The NDRC forecast that the impact of the measures would be noticeable in the market from the second half of next year.
As they reel from rising cost of commodities including edible oil and vegetables, Chinese have also had to contend with an unstable supply of fuel. A diesel shortage was reported throughout China, from eastern Shanghai to southern Guangdong province and central Henan province to Beijing, with long queues seen at many gas stations. Retail fuel prices were raised by up to 10% from November 1, adding to the operating costs of train and bus companies.
To curb inflation, the central bank has raised the one-year benchmark interest rate paid on bank deposits to encourage savings. It has also cut to 5% the previous 20% tax on interest earned in savings deposits. Even so, growing inflation prompts some economists to argue that there is still room for interest rate increase.
"We think there will likely be 150-200 basis points [bp] additional increases in the reserve requirement ratio, further selling or issuance of special Ministry of Finance bonds and PBoC bills, one to two more rate hikes within the coming three to five months, and a slight acceleration of yuan appreciation to 6 to 7% versus the US dollar next year," Deutsche Bank's Jun Ma said in a research note on December 12.
In his note on the most recent rate changes, Ma wrote: "November CPI inflation reached a new high of 6.9% year-on-year, raising the urgency to contain inflation expectations." Larger increases for three-month and six-month deposit rates "were clearly attempts to discourage depositors from moving funds out of the banking system [due to higher inflation expectations].''
The PBoC changes effective December 21 included increases of 45 basis points in the three-month term deposit rate and a 36 basis point rise in the six-month rate.
"Although the reserve ratio requirement [RRR] was raised by a more aggressive one percentage point recently, it could be partly explained by the specific need to sterilize the liquidity injection from large sums of maturing PBoC bills and forthcoming withdrawal of significant fiscal deposits by year-end. Therefore, the RRR increase would not be a perfect substitute for the rate hike," he wrote.
Yi Xianrong, an economist with CASS, earlier said expected the central bank to increase interest rates soon, since negative real interest rates had created an excessive credit and asset bubble.
Despite the country's measures to rein in the real-estate boom, including tightening credit to developers and increasing supervision on land use, the country's larger cities have all reported rapid growth in housing prices this year. According to the NDRC, average housing price in the mainland's 70 large and medium-sized cities jumped 10.5% year-in-year in November compared with October's 9.5% growth rate and September's 8.9%, fueled by robust investment and demand. Investment in the real-estate market jumped 31.8% in the first 11 months of this year from 2006 to 2.16 trillion yuan, the NDRC reported.
Investment in the real-estate market jumped 31.4% in the first 10 months of this year from 2006 to 1.92 trillion yuan, the National Bureau of Statistics reported. About 1.37 trillion yuan was invested in residential property in the first 10 months, rising 33.7% from the same period last year.
Clement Luk, director and assistant general manager at Centaline (China) Property Consultant's Shanghai office, believed second-tier cities will remain the focus for property investors for 2008, due to higher profit margin.
"Since some second-tier cities such as Tianjin and Chengdu have been well explored, some property developers have shifted their focus to third-tier locations such as Zhuhai, Weizhou and Dongguan," he said. Luk expected more tightening policies, including increases in interest rates and mortgage deposits. The central bank and the China Banking Regulatory Commission on September 27 raised mortgage deposits to 40% for second homes.
Stock volatility
With limited investment channels in China other than the property sector, the stock market has become the most favored target to boost income over the past year, China's stock market, which gained 130% in 2006, continued to surge in the first 10 months of this year, with the Shanghai Composite Index hitting a record high of 6,124 on October 16.
The number of new A-share stock accounts opened daily reached about 350,000 at their peak in April. As the country's stock markets became more volatile in the second half, the number of new accounts opened per day dropped significantly, falling to 122,000 in the last week of November, 37% down on the previous month.
Hu Weitao, chief investment officer of Valuefinder Investment Management Co in Shenzhen, expected the market downturn seen since last October to continue amid possible tightening monetary policy and sagging investment confidence.
The mainland stocks markets have gained about 88% this year, but concerns among mainland authorities that a bubble had developed eased with a contraction of about 20% from record highs set in October.
In a December 11 China Strategy research note, Morgan Stanley economist Jerry Lou ruled out a bubble scenario for Chinese equities, following the investment house's US economist's call for a mild recession in the coming year and seemingly aggressive tightening efforts by the PBoC.
Lou remained bullish on HK-listed offshore China equities in 2008. "We think corporate China can handle the three challenges including: 1) a US recession and export slowdown; 2) domestic asset price deflation; 3) monetary tightening and austerity controls, well through 2008."
The Hong Kong stock market is becoming increasingly Sinicized and more sensitive to central government actions as more funds, legal and illegal, enter Hong Kong from China and a significant number of mainland companies list in the former British territory.
Even as international funds cashed out, Hong Kong's benchmark Hang Seng Index gained 33% this year to mid-December, helped by the central government announcement in late summer that it planned to allow individual mainland investors to purchase Hong Kong equities. When Premier Wen Jiabao later said the "through train" plan might be delayed, the index retreated 5.01% on November 5 to close at 28,942.32, the biggest fall since the September 11, 2001, terrorist attacks.
This increasing sensitivity to mainland events is raising concern among some investors that the Hong Kong market in the coming year will fluctuate like its more volatile mainland counterparts, particularly in relation to government measures.
"It's getting obvious that the Hang Seng Index is driven up by mainland enterprises," said Conita Hung, head of equity markets at Delta Asia Financials. "Given the more volatile nature of the H-share index, the local stock market benchmark is likely to experience large fluctuations," she said. H-share companies are Hong Kong-listed enterprises incorporated in the mainland and with their main businesses based there.
As the central government tries to come to grips with worsening inflation and increasing trade surpluses, some analysts argue that a quicker appreciation of the yuan would help on both counts, while others contend that a sudden rise in the Chinese currency's value compared with the US dollar would not serve the interests of either China or the US.
A fast appreciation of the yuan would mean that "China will lose its competitiveness as the factory of the world, which will cost China its bargaining power with developed countries on product prices", Zhang Tingbin, deputy chief editor of China Business News, said in a recent column. "Faced with the subprime mortgage crisis, the most important task for the US government is to try to maintain the stability of the macro environment and of the exchange rate of dollars."
It is almost certain that the Chinese government will continue its gradualist approach toward yuan revaluation, recognizing that a quick change in the country's exchange rate would hurt the country's export-oriented manufacturing industries, putting the jobs of millions of workers at risk.
However, as PBoC governor Zhou Xiaochuan said recently, China may allow the yuan to float in a more flexible range, suggesting the government may expand the trading range in the new year. The yuan closed at 7.3797 to the US dollar on December 11, on the eve of the third round of the Sino-US Strategic Economic Dialogue in Beijing, a high since its revaluation in the summer of 2005. The currency has strengthened about 5.5% this year.
As the Chinese economy continues to grow strongly, the potential impact of a possible recession in the US looms large. Zhou Zhenhua, director of the Shanghai municipal people's government development research center, said the impact of the US subprime mortgage crisis will gradually be felt through to 2010.
"The impact of the subprime mortgage crisis will spread to the developed countries like those in the European Union and weaken their economies, which eventually will slow down China's export market," he said.
Fan Gang, a member of the central bank's monetary policy committee, however, said losses from a probable decelerating US economy could be offset by gains from European countries and Japan. "Past experience shows that a slowdown of the US economy will lead to a fall in China's exports to the US. In fact, in the past five years, China's exports to the US have been on the decline [in relative terms], so we think the probable US recession will have a smaller impact than we had expected," he said.
Fan also objected to the idea of a quick appreciation in the yuan, saying it would trigger large speculative capital inflows and outflows that would harm China's economic growth and financial stability.
Olivia Chung is a senior Asia times Online reporter.
(Copyright 2007 Asia Times Online Ltd. All rights reserved. )
SE Asia offers haven from US turmoil
By Shawn W Crispin
BANGKOK - To decouple or not to decouple, that is the question that will loom over Southeast Asian economies and markets throughout 2008.
Global investors are bracing for the possibility of a US recession next year, an increasingly likely scenario as the staggering scale of the subprime housing loan crisis comes into clearer view. Many now wonder whether Southeast Asia's trade-geared economies, after decoupling to varying degrees from their historical reliance on US-destined exports, now represent a countercyclical shelter against the US's anticipated economic storm.
Asian markets, led by China and India but closely followed by many Southeast Asian economies, have this year provided a high-growth, high-return hedge against the financial doom and gloom emanating from the US. China's and India's stock markets were up in dollar terms around 175% and 66% year-on-year through the second week of December, while Indonesia, Singapore and Malaysia climbed 50%, 26% and 38%, according to official national statistics.
Markets across the region dipped slightly this week on revived concerns of a US recession, as investors uprooted capital to cover subprime-related losses in America. But while US capital markets are still major factors in determining Southeast Asia's economic performance, past strong correlations between US demand and regional export growth has weakened significantly in recent years. Demand in China, Europe and, to a lesser degree, the Middle East all buoyed regional exports this year, helping to fill the economic gap left by slackening US demand.
The great regional hope going forward is that China, where only around 30% of total gross domestic product (GDP) is derived from exports, will be able to sustain growth in Southeast Asia's more trade-geared economies. There are varying degrees of regional vulnerability to a US recession. Exports destined for the United States in 2006 accounting for nearly 20% of total GDP in Singapore and Malaysia, 13% in Vietnam, 9% in Thailand, 7% in the Philippines and less than 5% in Indonesia.
At the same time, there is growing statistical evidence that the region has in recent years decoupled significantly from the US's demand cycle and that a slowing US economy could accelerate that process. According to investment bank Credit Suisse, the percentage of Asia's exports (excluding China and Japan) to the US fell over the seven-year period spanning 2000-2006, dipping from 21% in 2000 to 15% in 2006. Regional exports to China, on the other hand, in 2006 accounted for 19% of the region's total, up from 13% in 2000.
The research forecasts that a 10% dip in US imports next year would, measuring first-round impacts, shave 0.9 percentage points off GDP growth in Singapore, 0.8 pp in Malaysia and the Philippines, 0.6 pp in Thailand, 0.2 pp in Indonesia, and 0.1 pp in Vietnam. Most importantly, China would see a mere 0.3 pp decline due to sliding US demand for Asian exports, according to Credit Suisse, which goes on to state that "there is no statistically significant relationship between China's growth rates and those of the US".
To be sure, China's growing consumption of Southeast Asian-produced goods is still partially linked to the US - through China's processing and re-exporting the region's intermediate goods to US markets. Yet some regional economists point to growing evidence that China is consuming rather than re-exporting a growing percentage of its Southeast Asian imports, crucially including electronics and raw materials.
Commodity plays
High global commodity prices and seemingly insatiable Chinese demand for raw materials have buoyed several Southeast Asian economies, including Thailand, Malaysia and Indonesia. In particular, natural resource-rich Indonesia has piggybacked on China's economic boom, offsetting the negative economic impacts of a decade-long de-industrialization process through ramping up energy and commodity exports.
Malaysia has profited from spiking global palm oil exports, Thailand from value-added foods, and Vietnam from food commodities. HSBC regional economist Fredric Neumann ventures that even if the US goes into recession, global commodity prices would not collapse due mainly to Chinese demand. "It represents the first time that the commodity price cycle is not directly linked to US demand," Neumann says. "That's where you've really seen a Southeast Asian decoupling [from the US]."
It wasn't that long ago that Southeast Asia was more widely associated with its 1997-98 financial and banking meltdowns, underperforming economies and poor corporate governance records. After 10 years of varying degrees of de-leveraging and corporate restructuring, the region's economies' robust growth rates and strong current account surpluses now seem comparatively sound vis-a-vis the US and its subprime loan problems.
Most governments in the region now have plenty of fiscal room to implement countercyclical spending policies to help cushion the potential blow of a US slowdown on their domestic economies. Credit Suisse notes that domestic demand is already growing strong in China, with overall GDP expanding 11.9% year-on-year in the second quarter of this year, and is now gathering pace in several Southeast Asian economies.
Rising bank loans, growing cement sales and falling interest rates are, counter-cyclical to the US, revving Indonesia's economy, where GDP is on pace to grow 6% this year and next, according to Credit Suisse. Malaysia, meanwhile, is taking aggressive steps to boost domestic demand, including a recent boost to civil servant salaries and a government decision to allow beginning next year the 5 million contributors to the Government Provident Fund to make early withdrawals for home financing purposes.
Singapore, whose percentage of total exports to the US has fallen by half from 20% in the mid-1990s to 10% today, continues to defy economic logic through its extraordinary domestic demand-led growth, including a go-go construction boom which has helped lift GDP growth to around 8% this year. The island state recently flexed its financial muscle when the state-run Government Investment Corporation paid US$10 billion for a 9% stake in subprime loan hit Swiss investment bank UBS, making it the financial institution's largest shareholder.
Even politically troubled, economically laggard, Thailand is showing new signs of consumer and investor confidence, spurred in part by the myriad populist spending pledges all political parties on the hustings have promised to implement if elected at the December 23 polls - though most economic analysts agree that a full economic recovery in Thailand depends on a smooth transition from military to democratic rule.
Some economists argue that for Southeast Asia's decoupling story to hold, Europe must continue to grow strongly and consume a growing share of the region's non-commodity exports. The appreciation of the euro vis-a-vis the dollar (on a trade-weighted basis at its lowest level since the 1960s) and some regional currencies would nominally support that trend. But Europe's banks are also highly exposed to the US's subprime problems, and should broad investor confidence collapse, all emerging markets, including Southeast Asia's, would likely see massive capital outflows.
Other analysts believe that sustained fast growth in China will save the day. HSBC's Neumann points to potential capital upsides for the region, as China is expected to invest as much as $200 billion of its qualified domestic institutional investor (QDII) outward investment program into Southeast Asia and South Korea. The economic forecast may be gloomy in the US, but for global investors looking for a countercyclical safe haven from a US recession, they could do worse than punting on Southeast Asia's slowly but surely decoupling economies.
Shawn W Crispin is Asia Times Online's Southeast Asia Editor. He may be reached at swcrispin@atimes.com
BANGKOK - To decouple or not to decouple, that is the question that will loom over Southeast Asian economies and markets throughout 2008.
Global investors are bracing for the possibility of a US recession next year, an increasingly likely scenario as the staggering scale of the subprime housing loan crisis comes into clearer view. Many now wonder whether Southeast Asia's trade-geared economies, after decoupling to varying degrees from their historical reliance on US-destined exports, now represent a countercyclical shelter against the US's anticipated economic storm.
Asian markets, led by China and India but closely followed by many Southeast Asian economies, have this year provided a high-growth, high-return hedge against the financial doom and gloom emanating from the US. China's and India's stock markets were up in dollar terms around 175% and 66% year-on-year through the second week of December, while Indonesia, Singapore and Malaysia climbed 50%, 26% and 38%, according to official national statistics.
Markets across the region dipped slightly this week on revived concerns of a US recession, as investors uprooted capital to cover subprime-related losses in America. But while US capital markets are still major factors in determining Southeast Asia's economic performance, past strong correlations between US demand and regional export growth has weakened significantly in recent years. Demand in China, Europe and, to a lesser degree, the Middle East all buoyed regional exports this year, helping to fill the economic gap left by slackening US demand.
The great regional hope going forward is that China, where only around 30% of total gross domestic product (GDP) is derived from exports, will be able to sustain growth in Southeast Asia's more trade-geared economies. There are varying degrees of regional vulnerability to a US recession. Exports destined for the United States in 2006 accounting for nearly 20% of total GDP in Singapore and Malaysia, 13% in Vietnam, 9% in Thailand, 7% in the Philippines and less than 5% in Indonesia.
At the same time, there is growing statistical evidence that the region has in recent years decoupled significantly from the US's demand cycle and that a slowing US economy could accelerate that process. According to investment bank Credit Suisse, the percentage of Asia's exports (excluding China and Japan) to the US fell over the seven-year period spanning 2000-2006, dipping from 21% in 2000 to 15% in 2006. Regional exports to China, on the other hand, in 2006 accounted for 19% of the region's total, up from 13% in 2000.
The research forecasts that a 10% dip in US imports next year would, measuring first-round impacts, shave 0.9 percentage points off GDP growth in Singapore, 0.8 pp in Malaysia and the Philippines, 0.6 pp in Thailand, 0.2 pp in Indonesia, and 0.1 pp in Vietnam. Most importantly, China would see a mere 0.3 pp decline due to sliding US demand for Asian exports, according to Credit Suisse, which goes on to state that "there is no statistically significant relationship between China's growth rates and those of the US".
To be sure, China's growing consumption of Southeast Asian-produced goods is still partially linked to the US - through China's processing and re-exporting the region's intermediate goods to US markets. Yet some regional economists point to growing evidence that China is consuming rather than re-exporting a growing percentage of its Southeast Asian imports, crucially including electronics and raw materials.
Commodity plays
High global commodity prices and seemingly insatiable Chinese demand for raw materials have buoyed several Southeast Asian economies, including Thailand, Malaysia and Indonesia. In particular, natural resource-rich Indonesia has piggybacked on China's economic boom, offsetting the negative economic impacts of a decade-long de-industrialization process through ramping up energy and commodity exports.
Malaysia has profited from spiking global palm oil exports, Thailand from value-added foods, and Vietnam from food commodities. HSBC regional economist Fredric Neumann ventures that even if the US goes into recession, global commodity prices would not collapse due mainly to Chinese demand. "It represents the first time that the commodity price cycle is not directly linked to US demand," Neumann says. "That's where you've really seen a Southeast Asian decoupling [from the US]."
It wasn't that long ago that Southeast Asia was more widely associated with its 1997-98 financial and banking meltdowns, underperforming economies and poor corporate governance records. After 10 years of varying degrees of de-leveraging and corporate restructuring, the region's economies' robust growth rates and strong current account surpluses now seem comparatively sound vis-a-vis the US and its subprime loan problems.
Most governments in the region now have plenty of fiscal room to implement countercyclical spending policies to help cushion the potential blow of a US slowdown on their domestic economies. Credit Suisse notes that domestic demand is already growing strong in China, with overall GDP expanding 11.9% year-on-year in the second quarter of this year, and is now gathering pace in several Southeast Asian economies.
Rising bank loans, growing cement sales and falling interest rates are, counter-cyclical to the US, revving Indonesia's economy, where GDP is on pace to grow 6% this year and next, according to Credit Suisse. Malaysia, meanwhile, is taking aggressive steps to boost domestic demand, including a recent boost to civil servant salaries and a government decision to allow beginning next year the 5 million contributors to the Government Provident Fund to make early withdrawals for home financing purposes.
Singapore, whose percentage of total exports to the US has fallen by half from 20% in the mid-1990s to 10% today, continues to defy economic logic through its extraordinary domestic demand-led growth, including a go-go construction boom which has helped lift GDP growth to around 8% this year. The island state recently flexed its financial muscle when the state-run Government Investment Corporation paid US$10 billion for a 9% stake in subprime loan hit Swiss investment bank UBS, making it the financial institution's largest shareholder.
Even politically troubled, economically laggard, Thailand is showing new signs of consumer and investor confidence, spurred in part by the myriad populist spending pledges all political parties on the hustings have promised to implement if elected at the December 23 polls - though most economic analysts agree that a full economic recovery in Thailand depends on a smooth transition from military to democratic rule.
Some economists argue that for Southeast Asia's decoupling story to hold, Europe must continue to grow strongly and consume a growing share of the region's non-commodity exports. The appreciation of the euro vis-a-vis the dollar (on a trade-weighted basis at its lowest level since the 1960s) and some regional currencies would nominally support that trend. But Europe's banks are also highly exposed to the US's subprime problems, and should broad investor confidence collapse, all emerging markets, including Southeast Asia's, would likely see massive capital outflows.
Other analysts believe that sustained fast growth in China will save the day. HSBC's Neumann points to potential capital upsides for the region, as China is expected to invest as much as $200 billion of its qualified domestic institutional investor (QDII) outward investment program into Southeast Asia and South Korea. The economic forecast may be gloomy in the US, but for global investors looking for a countercyclical safe haven from a US recession, they could do worse than punting on Southeast Asia's slowly but surely decoupling economies.
Shawn W Crispin is Asia Times Online's Southeast Asia Editor. He may be reached at swcrispin@atimes.com
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