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China’s Macroeconomic Outlook: Monetary Tightening

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Presentation on theme: "China’s Macroeconomic Outlook: Monetary Tightening"— Presentation transcript:

1 China’s Macroeconomic Outlook: Monetary Tightening
See the Disclosure Appendix for the Analyst Certification and Other Disclosures China’s Macroeconomic Outlook: Monetary Tightening Don Hanna Asia Pacific Economic and Market Analysis Shanghai December 2004

2 Overheating or Overinvestment?
Growth of consumption, fixed capital formation and GDP (%) Source: China National Statistics Bureau, CEIC and Citigroup estimates.

3 Selective Tightening Policies
Policy Measures Implemented Tightening Liquidity by the PBOC Reserve requirements have been raised three time since September 2003 and currently the ratios are 8% for weak banks and 7.5% for all others Window Guidance by the CBRC Banks have been advised to slow lending to sectors with risks of bubbles and inspection groups have been dispatched to check banks’ loan portfolios Preferential supports to investment projects in areas such as coal, electricity, oil, transportation and water supply Control of Land Use by the State Council Investigation of irregular conversion of land use and tighter procedure for approval of new land development projects Consolidation of Investment by NDRC Consolidation through review of investment projects, targeting iron and steel, cement, office buildings, golf course, large shopping centers, etc However, projects in the following areas are not affected: agriculture, forestry, irrigation, ecological development, education and science Additional Policy Options Tightening Liquidity Open market operation or further raising deposit reserve requirement ratios Interest Rate Hike China began to raise interest rates to avoid negative real interest rates and substitute for administrative measures. Inflation could accelerate the plan Currency Revaluation Exchange rate policy reform is still driven by fundamental consideration, which may be delayed due to concerns about uncertainty in the economy

4 Tightening Slows Growth of Monetary Variables
Growth money supply M2 and bank loans (% yoy) Source: China National Statistics Bureau, CEIC and Citigroup estimates.

5 But Economic Activity Remains Robust
Growth of monthly fixed asset investment in 2003 and 2004 (% YoY) Growth of monthly retail sales in 2003 and 2004 (% YoY) Source: China National Statistics Bureau, CEIC and Citigroup estimates.

6 Changing Pattern of Investment Growth
Growth of fixed asset investment by industry (% YoY) Source: China National Statistics Bureau, CEIC and Citigroup estimates.

7 Core Inflation Is Set to Rise Quickly
Headline inflation likely peaking While headline and non-food inflation are still moderate, they climbed from deflation 2 years ago The official rates may still underestimate inflation pressures because of price controls High input prices is likely to push inflation higher. Earlier analyses suggest that (1) 1% increase in raw material prices leads to 0.3% rise in CPI with time lags; (2) $10/barrel rise in oil prices pushes up CPI by % Rapid growth of wages not only pushes up costs of production but also strengthens consumer demand in the markets Non-food CPI should grow further (%) Source: China National Statistics Bureau, CEIC and Citigroup estimates.

8 Power Shortage Became a Nation-wide Problem
24 out of 31 provinces experience rationing of electricity consumption. Total shortage can be 3-6% of expected demand and net impact on GDP could be 0.3% The government introduced new schemes to ease the shortages, including increasing investment, usage management and price liberalization Stand-alone generators significantly reduce the impact of power shortages, but they at the same time raise cost of production and pollute the environment Power shortages would not disappear until 2006E Source: National Statistics Bureau, and Chinese Academy of Social Sciences.

9 Shortage of Migrant Labor in Coastal China
Is labor supply unlimited? Number of migrant laborers reached 98mn in November-2003 and has been growing by 5% yoy Underdeveloped labor market – lack of information, low wages, poor social welfare benefits and skill mismatch Some employers are already paying 20-30% more to attractive workers; and social welfare contributions could account for 40-50% of payrolls Implications: hurting corporate profits, boosting consumption and adding inflationary pressure Rising urban unemployment rate (%) Source: National Statistics Bureau, and Chinese Academy of Social Sciences.

10 Beginning of Monetary Tightening
On 28 November 2004, PBOC announced changes to its interest rate policies Ceiling for lending rates were removed for commercial banks (with the only exception of rural credit cooperatives) and deposit rates were allowed to float downward, but not upward Base lending and deposit rates were raised, by 27bps for 1-year loans/deposits Changing lending rates, August 1996 – Oct 2004 (%) Source: People’s Bank of China and CEIC.

11 CNY May Appreciate At Least 25% in the Next 10 Years
GDP per capita and exchange rates relative to purchasing power parity at five-year intervals: Japan; Taiwan; Korea; and China 10 30 50 70 90 20 40 60 80 GDP per capita, percent of U.S. Exchange Rate relative to PPP (US=100) Korea Taiwan China Japan 1950 1975 1955 1995 1960 1980 2002 Source: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 6.1, Center for International Comparisons at the University of Pennsylvania (CICUP), October 2002.; and IMF, April 2003 WEO Database .

12 Asia’s Growth Is Linked to One Another More Than the US
Asia Pacific Asia’s Growth Is Linked to One Another More Than the US Business Cycle Concordance Based on GDP Growth Cycles Last 10 Years (1Q93-1Q03) Note: * Significant at the 10% level; ** Significant at the 5% level; *** Significant at the 1% level Source: Citigroup calculations based on John McDermott and Alasdair Scott, “Concordance in Business Cycles” IMF Working Paper No. 00/37 (Washington DC: International Monetary Fund) 2000

13 Strong intra-regional trade linkages
China and Intra-regional share in Asia Total Trade Source: CEIC, Citigroup estimates.

14 Long-term Asia FX forecasts show appreciation
Asia Pacific Long-term Asia FX forecasts show appreciation Nominal Exchange Rate and Implied Real Exchange Rate Appreciation Source: Citigroup estimates

15 Asian Macro Forecast: Hurt by Oil
Asia Pacific Asian Macro Forecast: Hurt by Oil Update as needed Source: Consensus Economics, Citigroup estimates

16 Tightening Did Not Solve the Fundamental Problem
GDP growth and total factor productivity growth as a share of GDP growth (% YoY, %) Source: National Statistics Bureau, CEIC and Citigroup estimates.

17 Costs of capital and potential returns to capital in China (%)
Capital Is Too Cheap! Costs of capital and potential returns to capital in China (%) Note: Borrowing costs for private companies are from survey by PBOC officials Xie Ping and Lu Lei and average return to capital of listed companies is from Citigroup. Source: Citigroup estimates.

18 Rebound of Nonperforming Loans
The government is accelerating its banking reforms. But are these sufficient? Source: China Banking Regulatory Commission and Citigroup estimates.

19 Asian Trade Reorienting Through China
Share in Total US Imports Source: CEIC, Citigroup

20 Pattern of Tech Dependence Shifting
Asia Pacific Pattern of Tech Dependence Shifting Sources: Citigroup calculations based on data provided by CEIC

21 China’s Regional Structure Likely to Remain Diversified
Domestic economic structure/costs will be diversified Cost advantages over some Asian economies are already quite limited GDP per Capita (US$) Source: Citigroup, China Statistical Yearbook and CEIC.

22 Education Still an Opportunity
Educational Attainment of Population 25+, 2000 Add VN Source: Barro & Lee

23 Governance May Be a Key to Growth
Governance Indicator (Aggregate) Note: Governance indicators are oriented so that higher values correspond to better outcomes, on an aggregate scale from –15 to 15. Aggregate include voice and accountability, political stability, government effectiveness, rule of law, regulatory quality and control of corruption indicators. Source: D. Kaufmann A. Kraay, and M. Mastruzzi (2003) • World Bank Policy Research Working Paper 3106

24 China – Macroeconomic Forecasts
Source: China National Statistics Bureau, CEIC and Citigroup estimates.

25 Disclosure Appendix ANALYST CERTIFICATION
I, Yiping Huang, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.


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