Liquidity and inflation

From “Comment on August CPI data,” by Jing Ulrich, China Equities Chairman, JPMorgan Securities, September 11 2007:

While the current spike in food prices will likely moderate as specific supply shocks are addressed, there are structural changes in consumption that could impact food inflation in the years ahead. As the country grows wealthier, the proportion of meat in the average Chinese diet will continue to increase – this has a multiplier-effect on demand for the agricultural commodities used to produce livestock feed. Yet China’s agricultural output is constrained by shortages of arable land and water. The current problem of supply volatility, which has severely compounded food inflation this year, will gradually moderate as producers adjust to demand and a range of new incentives for farmers takes hold. A number of these issues may ultimately be addressed through industry consolidation. China’s agricultural sector is still highly fragmented and the government is clamping down on small food suppliers … Going forward, the authorities may raise interest rates or the required reserve ratio again this year, and may consider new antispeculative measures on the property and stock markets. China’s leaders will monitor inflation very closely. However, we don’t expect aggressive action ahead of the 17th Communist Party Congress in October.

From “China’s two liquidities,” by UBS Chief Asia Economist Jonathan Anderson, September 10, 2007:

One question comes up again and again: “Doesn’t China need to reduce excess liquidity in order to slow the A-share market?” If you’ve come across this question in the recent past, we beg you to ignore it … There are two very different pools of liquidity in China. One drives the “real” economy, that is, macro growth and inflation. The other drives asset markets. And the two have almost nothing to do with each other. And, most important, the PBC only controls the first, with virtually no influence whatsoever on the second … In sharp contrast to the real economy, the domestic equity market is not driven by flow leverage creation; in fact, most funds coming into the market are being reallocated from within the existing pool of financial savings. And even today, after doubling and doubling again over the past 18 months, mainland free-float market capitalization is still very small compared to the outstanding stock of banking system deposits (RMB 8 trillion compared to RMB37 trillion) … China doesn’t necessarily need new liquidity inflows to drive the market; even without marginal credit creation, the existing stock of deposits would be sufficient to support gains through portfolio reallocation for a good while to come.  

From “Asian Development Outlook 2007 Update,” by the Asian Development Bank, September 2007:

Any substantial change in the current growth pattern is unlikely as long as the savings rate remains so high. Several studies of the country’s flow-of-funds tables show that the increase in the national savings rate between 1992 and 2003 came mainly from rising government and enterprise saving; household saving, in contrast, fell by 3% as a share of total disposable income in those years. This drop occurred mainly because the household share of national disposable income declined during the same period, from 69% to 63%, while the government and enterprise shares rose from 19% to 22% and 12% to 15%, respectively. Available data since 2003 suggest that this trend has continued. Household incomes have grown in the past decade, but not as fast as enterprise profits and government revenues. Therefore, lifting the share of total income going to households appears to be needed to achieve the economic rebalancing.

From “Asset quality improving, but caution still warranted,” by analysts Charlene Chu and Lydia Lin, Fitch Ratings, September 11 2007:

Historically the Achilles heel of China’s banking system, asset quality has improved dramatically over the past decade, a testament to the success of recent reforms … In general, we find that exposure to credit losses, while certainly still sizeable, is becoming increasingly manageable from both an institutional and sovereign standpoint. Rising loan loss provisioning and much-improved capitalization have significantly bolstered institutional resources to absorb credit losses … Meanwhile, the Chinese government’s own financial standing has dramatically strengthened, with foreign reserves now topping US$1.3 trillion, revenue intake on the rise, and government debt/GDP at a modest 22%. Nevertheless, these are good economic times, and history shows that even the worst banking systems can appear decent during periods of robust GDP growth … Fitch also emphasizes that China is in the midst of a strong economic upcycle so that NPL data collected during recent years may reveal quite little about what would happen under bleaker economic conditions.