Stagflation in China

A new research note from Wu Qing of the Development Research Center of the State Council, which is a key government think tank. I can’t find anything in English, so you’ll have to bear with my translation.

Chinese economy is moving from a temporary high growth, low inflation period towards stagflation. Economic data of May pretty much confirms this.

The inflation call is hardly surprising as many have noted that inflation is being transmitted downstream. What’s more interesting is the call of rapid slowdown of growth.

Since the major economies of Europe are not competitive in labor intensive products and the euro has depreciated against other currencies besides the RMB, Chinese exports to Europe may not suffer too much.

What could possibly impact Chinese exports is the rapidly escalating wages. …14 provinces and cites have hiked the minimum wage by an average of 20% this year, with 10 more to announce soon….

The IMF raised Chinese forecast GDP growth to 10% in April. However, Chinese economic growth is trending downwards, from 11.9% in Q1 to perhaps only 8% in Q4. Without new stimulus, growth may drop below 8% during the first two quarters of next year.

He sees inflation to peak in H2 this year but may lingers till early next year. Coupled with the expected slowdown in growth, China may see its first bout of stagflation in H1/2011.

Shanghai to impose property tax

Rumors abound that Shanghai will be among the first batch of localities to impose a 0.8% property tax (per annum, on appraisal value) on second homes, as these are classified as “for profit”.

After a series of tough measures, turnover at most cities have fallen dramatically while prices have not budged, as fat profits from last year help buttress most developers from cash flow pressure. This new tax is largely seen as a follow up to earlier measures, to make sure that policy control does work its way and cools China’s property market.

Many commentators are doubting the ability of the central government in achieving its policy objective. I think this is taking too sanguine a view, or perhaps too pessimistic, depending on your stance. Make no mistake, if the Chinese government truely wants to clamp down on housing prices, it will succeed. The runaway housing market has already turned into a political issue, and nothing political is taken lightly in China.

The real question should be what are the consequences? Will everything be just swell after property prices come down from outer space? There already are signs that liquidity squeezed out from the property market is wrecking havoc in other sectors of the economy, like the all important farm produce. Today there’s an interesting story in the Chinese media about Wenzhou speculators (oh, these folks are famed, and not just for making lighters) turning towards gold. One also need to bear in mind that China aims to reform its domestic utilities and resources pricing this year, by taking away the huge subsidies. All these factors just make the 3% CPI target increasingly untenable. The risk of a Q2 rate hike is very real, perhaps even at this coming weekend for the real paranoid.

Inflation data out

And they don’t look good.

April CPI was up 2.8% YOY (consensus at 2.7%), dangerously close to the 3% threshold set by the government. PPI up 6.8% YOY (vs. 6.7% forecast). The banks made RMB774bn new loans in April, a hefty 52% increase over March.

The plan was to tranquilize Chinese economy with policy measures and wait for the global liquidity tide to ebb. Well, this ain’t gonna happen. If anything, there’s more free money  now than ever.

Maybe it’s time to bite the bullet and hike interest rate. Either that, or people will soon start demonstrating ’cause they can’t afford vegetables.  The Tiananmen protest in 1989 started out as demonstration against raging inflation after all.

Runaway inflation in China

China is to release April CPI today and the consensus is about 2.7%. While this seems well within the 3% target, actual inflation on the ground is quite another story. One telltale sign is that PPI is forecast at a scary 6.7%. How long will it take for this to be transmitted downstream, or should we look for the factories bellying up instead?

The inflation story is so worrisome that even the PBoC has repeatedly cautioned against “heightened inflation expectation,” which it sees as a result of excess domestic and global liquidity, raging commodity prices, and rising wages and other domestic costs.

Since China’s growth relies heavily on investment, i.e. capital intensive, it is more sensitive to commodity price swings. The trade figures released yesterday largely confirmed this. Although China reported a surplus in April, as opposed to the slight deficit expected by many economists, it’s still down 87% YOY, despite decent recovery in global demand. The main culprit was surging imports, especially of commodities. Iron ore import was up 27% YOY, soya beans was up 13%…you get the picture. Considering the massive hikes in wages I blogged about earlier, unless China succeeds in reigning in its economy, commodity-induced inflation will eventually be transmitted to CPI, as early as May according to the pessimists.

And CPI may breach the 3% threshold even if  China succeeds in its endeavor. This is because China is mainly relying on policy measures to surgically cool down the property market, which is seen as the main problem, instead of truely mopping up liquidity. As such money squeezed out of property market simply flows to other sectors of the economy like farm produce. After a 40x (!!!) run up in price last year, garlic has gone from RMB9 per kilo in Q4/09 to RMB12.2 in April. 80% of farm produces monitored by the National Bureau of Statistics are seeing similar price increases and this is causing great consternation among the general public. Yes there are climate issues, but speculation definitely plays a significant part.

I had thought that China would hold off interest rate hike for much longer given the uncertainties in the global economy. I’m still of this belief but the Chinese government is now having rapidly diminishing room for maneuver, and might actually be forced into an unilateral hike in Q2, especially now that the ECB has entered into the competitive printing business as well.

From Bloomberg: Europe Rescue Lets China Tackle Asset Prices, PBOC Adviser Says

The European initiative will enable Chinese leaders to “focus more on containing risks in the domestic economy instead of worrying too much about the global risks,” said Li, appointed in March as one of three academic advisers to the People’s Bank of China.

He’s being nice. Helicopter Ben x2 means that China will be submerged in a tide of liquidity if it doesn’t act decisively.

Is China cooling off?

The April HSBC PMI released today seems to suggest so.While still expansionary, the index fell to a six-month low of 55.4. On the other hand, the official government index released on May 1 showed a slight improvement, due most likely to different models being used for seasonal adjustment and the fact that HSBC index focuses more on smaller, privately owned companies.

But there are signs that the tightening measures are gradually working through the economy. It’s been reported that the banks are scrambling for deposits as the PBoC withdraws liquidity and raised reserve requirements. Volume for property sales has collapsed, by as much as 60% in Shenzhen. Buttressed by fat profits last year, the developers have mostly avoided cutting prices so far. But if volume continue to wither, pricing pressure will eventually be felt, especially when the new property tax and massive new supply got rolled out.

The melodrama on the other side of Eurasia also demands attention. Contrary to popular perception, the EU is actually China’s largest export market. The RMB’s dollar peg means that it has racked up huge gains against the euro. After all,  there was a reason why the Europeans were mum on currency issue during the recent G20 summit. Troubles with your largest customer could hardly be positive for business.

So is China starting to cool off? I don’t think so, not for now anywayz. Although official CPI is still very benign, on the ground inflation is rather high, especially for food and necessities. Rumors galore for upcoming major adjustments for subsidies on gasoline and natural gas. But given the performances of other sectors of the economy, hiking the interest rate now probably isn’t quite prudent either.