China: policy risks to remain intensive in near term?

  • Tuesday, March 30, 2010
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  • Keywords:Policy
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According to Economist ,Mr JunMa from Deutsche Bank, Hongkong, that China will face greater pressure of Currency invaluation and CPI rise. following is his analysis:

Developments in recent weeks confirm our view that public pressure is translating into political mandates for more aggressive policy actions to curb property speculation. CPI inflation will likely reach 3% yoy in April, thus, increasing the probability for a rate hike in late April or early May. Outcomes for China's RMB reform are becoming increasingly binary: if the political atmosphere is not feasible for a regime shift in Q2, the odds of a broader-based US-China trade conflict will rise. Given that policy risks are likely to remain intensive for awhile, we reiterate our cautious outlook on the equity market in the near term, especially on property-related sectors.

 

More aggressive policy stance for property sector

Recent developments confirm our expectation that public pressure is translating into political mandates for tougher policy actions to curb property speculation, and the likelihood of a price correction in Q2 in major cities' high-end housing market is high. Public discontent over poor housing affordability, land speculation and hoarding by developers and SOEs, and distorted official statistics on housing prices has only escalated in recent months, despite the introduction of State Council measures in late December. The NPC held earlier this month also served as a platform for expressing the public discontent. Against this backdrop, the leadership is more now more determined than any time in the past one and half years to take aggressive actions on property market speculation. The Minister of Construction said during the NPC that property price stabilization "has to be achieved even if it appears difficult" ("不行也得行").

The most aggressive actions will likely target land hoarding, speculation and corruption. A week ago, SASAC ordered 78 large SOEs, whose core business is non-property, to submit their plans to exit the property market within 15 days. The Ministry of Land Resources increased the deposit requirement to 20% (vs. 10% before) on developers for land purchases, in addition to the requirement of a 50% down payment (vs. 20-30% before) in the month. In some cities, we expect policies against land speculation to get more aggressive than what is required by the central government. In recent days, the central government sent "inspection groups" to each province to monitor the imposition of local governments' property measures. The Ministry of Land Resources has ordered investigations into "land hoarding" cases between March and July, and each major city will likely penalize at least a few companies under this program. More official corruption scandals related to land transactions may be revealed.

Other options in the form of credit and tax policies are also available to the government. Bank regulators will coordinate with the Ministry of Land Resources and Ministry of Construction to curb lending to developers who are found to be involved in land speculation and hoarding. Facing tight credit quotas, banks also have the incentive to raise mortgage rates as a way to ration credit. Further, as the last resort, the government can announce the introduction of property tax (although not calling for immediate implementation) in selected cities. This announcement should have significant physiological impact on speculators.

 

April CPI inflation may rise to 3%, implying higher chance of rate hike a month later

We believe that March CPI inflation will slow modestly to 2.5% yoy, down from 2.7% in February, as food prices declined after the Chinese New Year. However, several factors suggest that CPI inflation may resume its upward trend soon, and hit 3% yoy in April. The daily agriculture price ended downward correction on 20 March, and rice prices are under some upward pressure due to the drought in Southern China. Prices of manufactured goods are picking up as manufacturing utilization has recovered sharply, and rentals/imputed rentals are on the rise following the surge in housing prices last year.

If indeed CPI inflation rises to 3% in April, we believe that this may trigger the first rate hike in late April or early May. If PPI is also trending up in April, then it would reinforce the argument for a rate move. While the view of various government bodies and policy advisors on when to raise rates differ (most of them see CPI inflation of 2-4% as a trigger), we believe a consensus is emerging for 3% CPI inflation as a threshold. This is partly reflected in the government statement in the NPC that the government targets 3% inflation, beyond which the government policies need to be seen as "responsive." Note that policy makers know the inflation numbers a few days before the end of the month, and the PBOC tends to act before the official release of the data.

 

RMB policy: outcomes may be binary

On RMB policy, we believe two things are certain. First, China knows that it will eventually need to move away from the current de facto peg to the USD. Second, China knows how to change it. The new regime for RMB exchange rate needs to involve two-way volatility against the USD to mitigate hot money inflows, and thus it will very likely be a flexible peg to a reference basket. However, the timing of the policy change has become less certain over the past weeks.

In recent weeks, the US has told China that "if you do not move, we will move" -- i.e., that without appreciation, there will be sanctions from the US. The letter from 130 members of Congress demanded that the Obama administration designate China as a currency manipulator in its Treasury Review on 15 April. The Senate will likely pass legislation that opens the door for tariffs on Chinese goods, and it is possible that the House will follow. Economist Paul Krugman and other policy advisors are trying to convince the US administration not to be afraid of China dumping US treasuries, as they believe China would be the biggest victim of such an action (which we disagree with).

All these high-profile pressures from the US have already turned out to be very counterproductive, as China will only move when its policy change is seen by the domestic audience as justified by domestic needs rather than yielding to foreign pressure. The Chinese policy makers have to deal with a growing and recently increasingly vocal nationalistic sentiment that basically says whatever the US is telling China to do is bad for China.

Given these complications, we believe that the probability of China's exchange rate reform in the very near term has somewhat declined. We would now assign a 60% probability of China moving in Q2. One good scenario under which China may find it as a window of opportunity in Q2 is that the US delays the Treasury review from the originally scheduled 15 April 15 to, say, June. We believe that during this period, the two sides should collaborate to avoid escalation of tensions, and the US administration should try hard to keep Congress quiet for a few weeks. If such an opportunity does not arise over the next three months, and the H1 Treasury review report has to include a written threat like "no movement from the China side will imply designation of manipulator status on 15 October," which will certainly elevate the tension to a higher level. It will provide additional ammunition to the Senate to push for legislation requiring punitive measures on China as a "currency manipulator," and will increase the pressure on the US Department of Commerce to consider currency manipulation as a justifiable basis for countervailing duties.

In sum, we believe the outcomes of China's RMB policy will likely be binary in the following sense: If China is given the chance to change its RMB regime in the coming months, it would be ideal for the global economy as it alleviates a significant source of global policy risk (including a major trade conflict and potential China dumping of US treasuries). However, should such a move not be possible, the bilateral relationship will likely deteriorate further and lead up to a greater probability of a broader-based trade conflict between the two largest economies in the world. Under this "bad" scenario, many market participants will fear that China's exports will fall, its GDP will slow, EM will see falling commodities demand from China, and – should China signal its unwillingness to support the Treasury market – US bond yields and mortgage rates will rise and property markets will be hurt.

  • [Editor:editor]

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