Download - Current Issues in in China Macro-financial Current Issues in China Macro-financial view Dr. CS Chu 朱家祥 CCER, Peking University [email protected] May, 2008

Current Issues in in China Macro-financialCurrent Issues in ChinaMacro-financial view

Dr. CS Chu 朱家祥CCER, Peking [email protected]

May, 2008

2www.beyondbond.comProprietary and Confidential

1. Exogenous Impact

• US sub-prime crisis- little direct impact.

PBC’s rarely invest in sub-prime security. China’s exports: mostly non-luxury necessities.

• Oil price hike: cost-push inflation.


2. Domestic problem: CPI• Inflation regime has arrived!

Monthl y CPI (1990=100)

95

100

105

110

115

120

125

2000

1年

月

2000

7年

月

2001

1年

月

2001

7年

月

2002

1年

月

2002

7年

月

2003

1年

月

2003

7年

月

2004

1年

月

2004

7年

月

2005

1年

月

2005

7年

月

2006

1年

月

2006

7年

月

2007

1年

月

2007

7年

月

2008

1年

月


How serious is the problem?

• Last quarter: 8.7%. Target: 5% in 2008 (almost impossible!)

• Food price is escalating, is this just sector inflation (change in relative price)? Wrong!

• Cost-push inflation alone is NOT a problem.

• Key: management of inflation expectation to avoid demand-pull.

• Price control never works.


MoneyKey: M2

In 2007, M2 Q to Q growth rates are:

21.3%, 22.6%, 25%, 23.8%.

M2

0100020003000400050006000

Q1 1

987

Q2 1

988

Q3 1

989

Q4 1

990

Q1 1

992

Q2 1

993

Q3 1

994

Q4 1

995

Q1 1

997

Q2 1

998

Q3 1

999

Q4 2

000

Q1 2

002

Q2 2

003

Q3 2

004

Q4 2

005

Q1 2

007


M2 really LeadsStatistical results show that M2 clearly leads two

components: fixed investment and retail sales.

Vicious cycle:

M2↑ →Investment↑ →export↑ →reserve↑ →M2↑

export↑ due to over capacity

M2↑ due to RMB FX rate.

Inflation is a monetary matter!


Remedy?

• Currently, it appears that China focuses more on price control.

• Correct remedy: loose price, tight money.

Tight price, loose money will never work.


How to tighten money?

• Raise interest rate• Increase reserve ratio• Open market operation

(government bonds)What has China government done

so far?


4 Rx rateTwo important rates that are keys to M2: interest rate and exchange rate.

Difficult situations: negative real + hot moneyClear strategy:Raise both rates- Easy to say, too much to pay!


Covered interest parity

• S=spot FX rate, F=forward FX rate.

Dilemma

• (economic downturn), (Inflation),

• , while S is controlled within .

*1

1

rS F

r

*r r *1

1

r

r

F 0.5%


Implied Spot rate When CIP holds

Assuming no arbitrage, what would the spot rate looks like?

Actual and NDF-implied spot exchange rate between CNYand USD, 1999.1-2008.1

6.507.007.508.008.509.009.50

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

implied spot exchange rate Spot exchange rate


Consequence 1: Hot money

To do what? Interest rate spread, RMB appreciation, stock and housing market.

- 50

- 40

- 30

- 20

- 10

0

10

20

30

40


Consequence 2:

• Puzzle: M2/Y=1.6~1.8. Velocity is decreasing! In the US? About 0.6

• Consequence 3: PBC raised reserve ratio 12 times since 2007, up to the current 15.5%, all time high in 22 years.

2M


How tough is the challenge?

• FX rate : (1) Slowly appreciating: encourages speculation. (2) One-time appreciation: by how much? Concern: Exports ↓→Idle capacity ↑ .

• Tighten by (1) ↑ Interest rate or (2) ↑ reserve ratio?

Currently, China chose the direction of

Slow appreciation +tighten by reserve ratio.


5 Where does the money go?

• Negative real interest rate, money has to somewhere; hot money flows in, cannot park in saving deposits.

• Money goes to assets markets, obviously.

.


Stock Market

• Stock market, 50% down.

Crazy market…..i.e. CPC H share and A share are priced very differently.

• Non-floating shares will hit the market eventually. (大小非 )

• QDII suffer international financial turmoil.

• QFII: minding their own problem.

• HK express: temporarily terminated.


Let’s go bottom fishing?

• Maybe some other time!

• Long term factor in China’s stock market: “financial stability”.

Macro assessment to current China’s financial stability: Instable!


Housing Market• Very thin bonds market. 50b Treasury bonds sold

out in 2 hours!

• If stock market is not a good place to go, housing market is the only option.

• Simple logic: housing price will continue to rise.

• Negative impact: Government intervention, not affordable, too much speculation, Olympics?


Correlation

• Returns on stock and housing markets are positively correlated in financially instable period.

• On the other hand, they are more or less substitutes.

Guess: Financial crisis symptom: escalating housing price.


NPLHigh reserve ratio indeed tightens the money. Slow

down the credit expansion. Who gets the loans?

Never small and medium enterprises!

Large SOE, and backdoor loans are more likely. What will trigger “financial crisis” ? When macro economics gets really bad.


6 Financial Stability• Hard to define.

• No bona-fide financial crisis in China. There are hidden!

• IMF initiates FSAP, asking all central bankers to issue financial stability review (FSR).

• PBC started FSR cover in 2005. Basically lip-service nonsense.


Macro Financial Stability Index• Two dimensions: level and volatility • Constructed based on 24 macro financial variables. Most

important ones: M2, domestic credit, real exchange rate, and real deposit rate.

0

0.5

1

1.5

2

2.5

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-100

-50

0

50

100

150

vol l evel


Warning~• Both level and volatility index reached all time

high at the end of 2007.

• Deteriorating macro financial will trigger turmoil in banking sector via NPL.

• Inflation alone will not cause financial crisis, it causes social unease, and compound the financial trouble.

Download - Current Issues in in China Macro-financial Current Issues in China Macro-financial view Dr. CS Chu 朱家祥 CCER, Peking University [email protected] May, 2008

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