It seems the weird period of money-market tightening seems to have abated, at least for now. My SWS colleague Chen Long tells me the following:
The PBoC has injected liquidity through open market operations for the 16th consecutive week. The central bank issued RMB 1 billion in 3-month bills and RMB 1 billion in 1-year bills into the market with 3-month bill yield up marginally, and took out another RMB 40 billion in the form of repos, but maturing bills and repos resulted anyway in a net injection of RMB 103 billion. In addition the PBoC disclosed that they purchased RMB 501.6B of net foreign currency inflows in January, far beyond market expectation of roughly RMB 400 billion or less.
Clearly there is a lot of money sloshing around, driven in part by large foreign currency purchases by the PBoC. Chen Long adds:
The 7-day repo rate dropped below 3% on Thursday, and the yield curve dropped in the short end, with the 3-month bill yielding as low as 2.57%, the first time in almost one year that the yield in the secondary market is lower than the primary market.
What does all this mean? Probably that we can expect the PBoC to issue more sterilization bills and that minimum reserves will rise another 100-150 bps before the tightening cycle is over. Certainly there are lots of rumors about an upcoming 50-bp hike.
In that context it is interesting that in his state-of-the-nation report (we are in the midst of the CPPCC and NPC meetings, which of course are the prime focus of economists and policymakers in China right now), Premier Wen put “keeping the price level stable” as the top priority. Chen Long reminded me that this is the first time in the past decade that growth is not mentioned in the first place.
What’s more, “increasing household consumption” is listed in the second place. This has never happened before either.
This change in the premier’s focus is noteworthy, but I don’t think we should assume that there is a strong consensus among policymakers. On the contrary, I think there is evidence of a lot of confusion and disagreement, and policymakers are basically agreed only on the very short term – to crush inflation some time in the first half of 2011. Beyond that, I expect there will be strong disagreement, and my own expectation is that as we approach the end of the second quarter there will be rising pressure to release the constraints and kick out another burst of investment-led growth.
Chen Long goes on to say:
Last week we had conversations with some mid-level officials in Beijing and they said that their impressions are that all policies, including monetary policy, are dominated by very short-term needs. Controlling inflation is the top priority in the first half and credit policy will tend to be relatively tight, but they expect that monetary and credit policy will loosen in the second half if growth shows some sign of slowdown. It also looks like there are some serious disputes among policymakers at the moment.
I think that growth will indeed slow sharply if Beijing is serious about tightening credit growth. In that case, however, it is almost certain that we will stomp once again on the investment accelerator. We are still veering from panic to panic.
…Earlier in this newsletter I pointed out that there were reports that Beijing may be planning to increase consumption by 2-3 percentage points during the 12th Five Year Plan. Not everyone agrees. Last week my SWS colleague Chen Long sent me the following:
We have more news about targets for the consumption share of GDP today. A member of the CPPCC National Committee said China should start reform immediately to boost the share to 40% or even 50% by 2015. He thinks the official target is too conservative. He said the official target of 2-3pps increase of the consumption’s share of GDP is too low and too conservative.
The National Committee member is right, of course. 2-3 percentage points will do almost nothing for China’s rebalancing. Raising household consumption to 40-50% of course would be ideal.
But not easy. Let’s do the math. The household consumption share of GDP was above 50% in the 1980s but declined slowly to a low 46.4% in 2000. Thereafter it all but collapsed to 35.1% in 2009 (I have already explained why I think this was a consequence of the banking crisis at the end of the 1990s).
This shouldn’t have been a surprise. Household income growth sharply underperformed GDP growth in the past decade as well. Although the 2010 data has not released yet, there is reason to believe that household consumption number is likely to clock in around 35-36% of GDP. The National Bureau of Statistics announced on Tuesday that urban and rural household income grew by 7.8% and 10.9%, respectively, sharply lower in the aggregate than GDP growth. Under those conditions it is reasonable to assume that consumption growth did not keep pace with GDSP growth either.
If over the next five years consumption is going to grow from 35-36% of GDP, its current level, to 40-50% of GDP, then consumption growth will have to outpace GDP growth by anywhere from 2.9 to 7.9 percentage points. So if China indeed grows over the next five years by the 7% predicted by Premier Wen, consumption has to grow by anywhere from 9.9% to 14.9% annually to get China to the target.
That’s going to be very hard without a significant change in corporate governance, i.e. a massive transfer of wealth from the state to households – which may be just another way of saying “privatization”, which is not (yet) on the cards. Even when GDP was growing at 10% and more, consumption growth only averaged 7-9%. Somehow without a major structural change in the growth model we are planning to lower GDP growth sharply while raising consumption growth to levels never before seen in Chinese history. Of course if GDP grows at 8-9%, which many people still believe, consumption will have to grow by a minimum of 11-12% just to get us to a 40% consumption share.
Its theoretically possible, of course, but unlikely. Far more likely is the Japanese route – slightly slower household consumption growth and much, much slower GDP growth. If household consumption grows at 7% annually for example, and GDP grows at around 4% annually, by the end of the five-year period household consumption would be around 40% of GDP (which only five years ago was already considered astonishingly low).
Take your pick. If the trade surplus is constant and investment growth flattens out, either consumption growth has to surge to levels never before seen in history, or GDP growth must slow sharply. If the trade surplus declines, we need an even more extreme choice. Most importantly, if Beijing is successful in slowing investment growth, all of my numbers will be wildly optimistic.
Of course Beijing can simply keep jacking up investment levels. But who will pay for all the waste? The household sector of course. In that case what prevents consumption from declining even further? I have no idea. The problem with arithmetic is that there is no way to add two and three and get seven or eight. The damned equation always adds up to five.
And from Bloomberg, Pettis on video.