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

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Presentation on theme: "Current Issues in in China Macro-financial Current Issues in China Macro-financial view Dr. CS Chu 朱家祥 CCER, Peking University May, 2008."— Presentation transcript:

1 Current Issues in in China Macro-financial Current Issues in China Macro-financial view Dr. CS Chu 朱家祥 CCER, Peking University jxzhu@ccer.edu.cn May, 2008

2 www.beyondbond.com Proprietary and Confidential 2 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.

3 www.beyondbond.com Proprietary and Confidential 3 2. Domestic problem: CPI Inflation regime has arrived!

4 www.beyondbond.com Proprietary and Confidential 4 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.

5 www.beyondbond.com Proprietary and Confidential 5 Money Key: M2 In 2007, M2 Q to Q growth rates are: 21.3%, 22.6%, 25%, 23.8%.

6 www.beyondbond.com Proprietary and Confidential 6 M2 really Leads Statistical 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!

7 www.beyondbond.com Proprietary and Confidential 7 Remedy? Currently, it appears that China focuses more on price control. Correct remedy: loose price, tight money. Tight price, loose money will never work.

8 www.beyondbond.com Proprietary and Confidential 8 How to tighten money? Raise interest rate Increase reserve ratio Open market operation (government bonds) What has China government done so far?

9 www.beyondbond.com Proprietary and Confidential 9 4 Rx rate Two important rates that are keys to M2: interest rate and exchange rate. Difficult situations: negative real + hot money Clear strategy: Raise both rates- Easy to say, too much to pay!

10 www.beyondbond.com Proprietary and Confidential 10 Covered interest parity S=spot FX rate, F=forward FX rate. Dilemma (economic downturn), (Inflation),, while S is controlled within.

11 www.beyondbond.com Proprietary and Confidential 11 Implied Spot rate When CIP holds Assuming no arbitrage, what would the spot rate looks like?

12 www.beyondbond.com Proprietary and Confidential 12 Consequence 1: Hot money To do what? Interest rate spread, RMB appreciation, stock and housing market.

13 www.beyondbond.com Proprietary and Confidential 13 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.

14 www.beyondbond.com Proprietary and Confidential 14 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.

15 www.beyondbond.com Proprietary and Confidential 15 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..

16 www.beyondbond.com Proprietary and Confidential 16 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.

17 www.beyondbond.com Proprietary and Confidential 17 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!

18 www.beyondbond.com Proprietary and Confidential 18 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?

19 www.beyondbond.com Proprietary and Confidential 19 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.

20 www.beyondbond.com Proprietary and Confidential 20 NPL High 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.

21 www.beyondbond.com Proprietary and Confidential 21 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.

22 www.beyondbond.com Proprietary and Confidential 22 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.

23 www.beyondbond.com Proprietary and Confidential 23 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.


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