From “China’s solid external position buffers it against global turmoil,” by Grace Ng and Qian Wang, JPMorgan, July 18, 2008:
The turmoil in US financial markets, especially since solvency fears arose lately about the two giant mortgage finance enterprises, has raised concern about potential losses on major Asian central banks’ holding of those entities’ debt. Indeed, data from the US Treasury International Capital (TIC) reports show that China’s net purchases of US government agency securities have risen steadily in the past two years, even outpacing its purchase of US treasury securities … Total holdings of US agency long-term debt amounted to US$376.3 billion as of June 2007. In the near term, the value of these is unlikely to have much impact on China’s foreign asset position, as liabilities of the giant US mortgage finance enterprises are expected to be backed by the US government. In the medium term, however, the latest episode highlights the risk that, in consistently “recycling” its current account surplus into USD assets, China may expose itself to a non-negligible share of the fallout from US financial difficulties, underscoring the need to further diversify China’s forex assets.
From “Macro Roundup: China’s Policy Dilemma,” by Moody’s Economy.com Economist Sherman Chan, July 18, 2008:
The Chinese government has perhaps always placed a higher priority on growth and economic development than anything else. This reinforces our forecast that monetary policy will be on hold for the third quarter, in order to sustain growth. In fact, there are increasing calls that monetary tightening should slow because of plummeting investor confidence. Chinese property and stock prices are retreating. But the consequences of adjustment in asset markets has been surprisingly orderly. The over-inflated balloon that was the Chinese stock market has seen air seep out steadily rather than an outright popping. This has meant that the necessary adjustments in asset prices have had less adverse effects on the rest of the economy than could have been the case, and that no rescue measures have been needed.
From “China Strategy,” by Minggao Shen and Ken Peng, Citigroup Global Markets, July 2, 2008:
The adjustment of China’s fuel and power prices on June 19 reflected policymakers’ recognition of the mounting costs of price distortion … When international oil prices averaged US$72/barrel, China’s oil price subsidies totaled US$8.2bn, or 0.2% of GDP. Now that oil prices have nearly doubled, the subsidy bill could well exceed 1% of GDP … Though a step in the right direction, the adjustment so far would do very little to alleviate shortages and encourage efficiency. There are still no provisions for adjustments according to market pricing. Continued price controls over coal would still create shortages for power generation. The distortions remain large even after the recent hike [and] the price of fuel will probably be adjusted again later this year. Another energy price hike of similar magnitude could take non-food inflation to a range of 2.5-3.0% by year-end. Combined with the expected slowing in food prices, headline inflation could reach 6.0-6.5% by year-end, consistent with our forecast for 7.4% CPI inflation for 2008 on average.
From “How Much Should China Be Worried about ‘Hot Money’,” by UBS Senior China Economist Wang Tao, July 11, 2008:
The fact that the PBOC has been able to sterilize most of the inflows is a testament to its achievement and creativity, but it does not mean that the challenge is not big, or that this process should be sustained. Most, not all, of the inflows were sterilized, leading to a net injection of liquidity from foreign exchange (FX) flows, and resulting in low interest rates. The increasing reliance on reserve requirement hikes to sterilize FX inflows and credit rationing can keep overall loan growth from rising too rapidly, but they add cost to banks and increase the risk of misallocation … Moreover, the overhang of liquidity threatens to translate into rapid loan growth through administrative loopholes, undermining the effectiveness of credit management. While the current high inflation has so far been caused mainly by higher food prices rather than excess aggregate demand, we think continued generation of liquidity would be like accumulating gasoline next to a fire … We expect further tightening in FX controls through increased monitoring of FX-related transactions including current account FX transfers, the final usage of FDI, and export/import invoicing. A one-off revaluation may help in managing appreciation expectations as well as reducing trade-related FX inflows. However, we think this is highly unlikely given the weakening external demand and uncertain global economy.
