China’s economic transition & inflation shock
Xu Sitao
Chief Representative, China, The Economist Group
Director, Global Forecasting, China,, Economist Intelligence Unit
Key points
• China’s inflation scare
• Asset bubbles: causes, policy measures and implications
• Policies to improve social welfare
• Risk scenarios & Investment implications
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Diagnosing inflation
• Short term concerns focused mostly on food. Supply shocks could send prices higher; PBOC’s target (4%) looking hard to achieve
• The impact of food prices is over-estimated but the effect of services is under-estimated; the net-effect is under-estimation of inflation
Source: EIU & CITI
• Factor price normalisation will put upward pressure on prices for electricity, water, other utilities, wages and cost of capital etc.
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CPI Cor e CPI Non- Food CPI Ser vi ce CPI Food CPI ( RHS)
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85 87 89 91 93 95 97 99 01 03 05 07 09 11
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Smal l & Medi um Banks RRR Lar ge Banks RRRExcess Reser ves 1- Year Deposi t Rat e ( RHS)1- Year Lendi ng Rat e ( RHS)
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China’s exit strategy is being executed
Discussion on inflation, labor market & demographic dividend
• Inflation, if mainly caused by food, would benefit farmers, but urban poor would be worse off ,
• Is inflation caused by demand or supply?
Factor price normalisation is underway
• What are factor prices?• Why is normalisation good for
China? • Will normalisation result in inflation?• Examples: fuel prices, Hukou
system, interest rate deregulation• Sequencing• Will inflation scare affect normalisation?
Housing market remains robust despite repeated anti-speculation policies
• Strong housing market is being underpinned by lack of other investment choices & liquidity
• Recent policies in Beijing tighten scope for non-residents to enter market
• Other policies aim to reduce leverage
• Shanghai and Chongqing are experimenting with property taxes
• Beijing – the only city to pledge price reductions of properties
“China is Dubai times 1,000, if not a million.”--- James S. Chanos
Erdos, Inner Mongolia
Is this the end of the Chinese economic miracle?
Why short China… (according to James Chanos)
• Land prices surged faster than property prices in some Tier 2 cities. This is backed up by Ministry of Land & Resources data for recent years.
• Therefore, we expect margin pressure for developers that entered such Tier 2 cities in recent years.
• Oversupply approaching; Tightening measures extended to Tier 2 cities.
• Consequences of bubble bursting (banking sector, related industries, consumers, external impact…)
China’s 12th Five-Year Plan:
• Shift: from quantity of growth to quality of growth and sustainable development
• 1/3 of PM Wen’s Govt work report speech focused on livelihood of common people
• Pledge to significantly increase stock of low income housing
• Reiterate inflation target of 4%
Prepare for Currency appreciation
• RMB appreciation occurring in both real and nominal terms
• Real appreciation (China’s tolerance of inflation) will take center stage the next a few years
• A rise in the value of the RMB is consistent with factor price normalisation
Pros
• Trade surplus shrinks but is still significant in absolute terms
• Foreign reserves rise despite promotion of outbound investment
• Politicization of issue in US: House of Reps Currency Reform for Fair Trade Act; Krugman’s “Taking on China”; Samuelsson’s “Stand up to China”
• Growing international pressure on China to implement “exit strategy” and support global rebalancing (especially after the quake in Japan)
• Without exchange rate adjustment, asset bubbles may grow
RMB Revaluation – Ongoing debate (in the wake of shocks from oil and quake)
Cons
• Revaluation hampers recovery of export industry
• RMB is already appreciating against the Euro on trade-weighted basis due to sovereign risk
• Widening inflation differentials between China and the US will result in a stronger RMB in real terms
• Labor shortages and price reforms will increase pressure on thin export profit margins
• China should not have to “pay” (by revaluation) for global imbalances arising from irresponsible monetary policies in other countries
A Chinese Prescription: A more open capital account while a relative stable RMB
• RMB’s is likely to appreciate less than the market has discounted
• China will come up various creative ways of exporting her vast savings
• Interest rate reregulation is imminent
Discussion & debate on fiscal reform
• Is China a high-tax country?
• Likely changes on personal income tax (why so much attention?)
• Discussion on property taxes
• The link between fiscal reform and financial deregulation
• Goalpost of public finance reform
• Political and social factors affecting tax cut
Risks, policy responses & Unintended consequences
• Risks of stagflation in the developed countries and heightened inflation in the emerging world;
• Contradiction between housing-for-the-people and local governments’ dependence on revenues from property;
• Forced appreciation of the RMB, triggered by QE3 (Japan’s experience in the ’80s) when China is facing persistent upward pressure on labour wage rate