My Blog

August 1, 2008

The stock market started out badly today, dropping 1.8% during the first two hours of the trading day, before a press conference by Hu Jintao, stressing the need for growth, brought back optimism over government-engineered policies to boost growth.   From its low the market surged 2.8%, to close at 2802, up 0.9% for the day.  According to an article in today’s Financial Times:

Answering questions solicited beforehand, Hu used carefully worded answers to flag hopes to tame inflation while keeping the engines of growth primed, and he held out the prospect of some political reforms in the wake of the Olympics.  ”We must see that currently there are uncertain and unstable factors in the international environment, and China’s domestic economy faces increasing challenges and hardships,” he said.

Hu singled out inflation as a big concern but balanced that with a call for continued growth.  “We must maintain steady, relatively fast development and control excessive price rises as the priority tasks of macro adjustment,” he said.

None of this should have been a surprise.  There have been rumors for weeks of a shift in orientation and last week’s Politburo meeting and PBoC announcement have pretty much confirmed that the authorities are far more nervous about slowing growth than about rising inflation.  Of course lip service continues to be paid to fighting inflation largely, I suspect, because many seem to believe that inflation is more likely to be a consequence of rising inflationary expectations than of rising money supply.

As part of this effort to boost growth – and clearly as a sop to angry Southern exporters – export rebates were reduced effective August 1, according to an article in China Daily.  My student Cui Enze, who is currently in an internship in New York, reports in an email today:

On July 30, State Administration of Taxation published a new policy that reduced textile industry export rebates ratio from 13% to 11%.  Obviously this policy is in response to ease the strong complaint from exporters and aimed to stop the slowdown of textile exports.  A government official in NDRC attributed the difficulty of textile exporters to four reasons, RMB appreciation, external demand slowdown, labor and material cost rise and domestic macroeconomic policy including export rebates, among which RMB appreciation is the most important.

There are also strong rumors – and of course not at all unexpected – that the strict new lending caps announced late last year are going to be further softened.  According to an article in the South China Morning Post, “China’s central bank has raised banks’ lending quotas by 5 per cent, banking sources said on Friday, the most substantial move yet by Brijing to prop up the economy in the face of slowing demand for the country’s exports.”  Because this move hasn’t been put in writing – it was apprently announced during meetings on Thursday, according to unnamed sources – it is not totally clear what this actually means in terms of loan volume, but it is clear that loan caps are being relaxed.  

It is worth pointing out that the recent surge in bank deposits means that loan caps have been a far more serious constraint on lending than have the several increases in minimum reserve ratios.  This relaxation comes just in time.  An article in the current National Business Daily warns that, given current rates of loan growth, the existing lending caps mean that by November Chinese banks will have to stop all new lending.

More interesting to me was the announcement yesterday in the China Securities Times of the creation of a new department within the PBoC whose mandate, it seems, is to coordinate and manage foreign exchange policies.  Cui Enze also compiled information about this in his email to me.  He continues:

A new department launched within the PBoC – the Exchange Rate Department – has just been approved by the State Council.  This new department will combine part of the PBoC's monetary policy department, financial market department and also parts of the functions of SAFE, and it will be an individual department dealing with exchange rate policy research and formulation.

This suggests that the government wants to pay more attention and place a more important status on the exchange rate.  It will help also help smooth the process of exchange rate reform.  Moreover, it is very interesting to note that under the current difficult conditions that this Exchange Rate Department has been set up.  I think it is a preparation for more aggressive RMB reform. So far, no time schedule has been set.   

A very interesting report on ChinaStakes.com gives us additional color:

The PBoC has twelve departments and six bureaus. The exchange rate office currently operates under the Monetary Policy Department. Now the PBoC seeks to strip the exchange rate office from the Monetary Policy Department and make it an independent department.

A researcher，under anonymity, at the Chinese Academy of Social Sciences told Chinastakes.com that by making the exchange rate office an independent department, the PBoC may reinforce the influence of exchange rate policy in macroeconomic control in future. The Monetary Policy Department is the most important department at the PBoC. The director of this department will usually be promoted to a higher position in the PBoC.

It has been three years since the launch of exchange rate reforms in July 2005. The establishment of the Exchange Rate Bureau indicates the increasingly important or even key role of exchange rate policy in China’s current monetary policy system.

It may also mean that the Monetary Policy Department is unable to formulate internal and external monetary policies at the same time, and it may be better to transfer the responsibility of making exchange rate policy to the Exchange Rate Bureau, so the Monetary Policy Department can focus on domestic policies such as interest rates, and credit.

Victor Shih has an early and thorough analysis on his RGE blog entry of what this may mean, and some of the potential problems that may arise.  To me it is interesting that they are trying to coordinate exchange rate policy within the larger context of capital flows in China and abroad and local financial markets.   China’s monetary policy is, for the most part, simply an extension of its currency regime and it does make sense to place the exchange rate at the center of a whole set of policies.  

I am not sure, however, about separating monetary policy from the exchange rate policy, but perhaps this is in preparation for a future in which the PBoC will actually be able to determine domestic monetary policy (after the currency floats?).  Whether Enze is right – that this is preparation for more aggressive RMB reform – will take time to decide, but my guess is that whether or not that is the intention, when the exchange rate moves back squarely back into the center of the policy debate, as I expect it to do by the end of this year, this department may play an increasingly important role in Chinese policy formulation.

Comments (9) for "Export rebates, relaxed lend...

Michael, I enjoyed reading your blog. I am not sure if I understood it correctly here about the export rebate. Isn't reducing export VAT rebate a bad thing for the exporters? If your student is right, then instead of getting a 13% VAT withdraw, the exporters are not getting only 11% back? Could you clarify this? By Lei Jiang - 7/31/2008 10:24 PM

PMI is below 50 for the first time in history. You got to be suicidal to not loosing the credit a bit. As for inflation, if economy keeps weak like this, commodity prices will be contained. Then, there is not much to worry about. By fatbrick - 7/31/2008 10:28 PM

Lei Jiang, it is indeed the opposite, tax rebates have been increased: http://www.bloomberg.com/apps/news?pid=20601089&sid=aiO5OaX5q3VM&refer=china By Eduardo Guelman - 8/1/2008 1:18 AM

Thanks. Eduardo By Lei Jiang - 8/1/2008 2:25 AM

Thanks Eduardo. Fatbrick, the official PMI is below 50, but it has proven pretty worthless as an indicator in the past and it doesn't make sense to take it too seriously. CLSA's PMI is above 50 (I want to say 53-54, but I don't have the data in front of me), and that may be a better indicator. I disagree with you about inflation. The idea that a slowing economy automatically reduces inflationary pressures is widespread but not borne out by the evidence and certainly contrary to the monetary model of inflation. In the past rising inflation has more often been part of a slowing economy than a rapidly growing one. For example if you look at the US in the past 40 years, the only serious bout of inflation came in the 1970s, when the US was also experiencing rising unemployment. If there is excess money in the system, the result is likely to be excess demand at current prices, which drives prices up. If commodity or food prices are rising particularly quickly, they absorb the excess demand -- but they are not the root cause of inflation. If commodity prices decline, my guess is that this will reduce their ability to absorb the excess demand and so that the price effects of excess demand will spread elsewhere. This happened, for example, in Latin American in the 1980s, a period during which declining commodity prices and rising unemployment came, nonetheless, with rising infaltion and even, in some cases, hyperinflation. By Michael Pettis - 8/1/2008 3:48 PM

As long as a central bank is committed to a fixed rate currency regime, it loses 'control' over monetary policy by its forced protection of 'E.' A floating rate regime, however, places all monetary policy squarely in the hands of the central bank. But doesn't the elevation of the importance of the bureaucracy for Exchange Rates at the PBoC actually mean that rates are going to continue to be fixed? Why have a more important bureaucracy for monitoring the currency if the long-term intent is to abolish controls over the RMB? The heightened importance of monitoring Exchange Rates suggests that the trading range might be expanded again in the near future, say to .5% or .7%, but I'm not sure how making regulating Exchange Rates more important means that the RMB might be allowed to float. Floating the RMB is the better policy economically, but the exporters would howl politically! By a Duoist - 8/2/2008 4:16 AM

Michael, I think the high unemployment rate in US in 1970s was caused by the high interest rate used by Fed to combat the inflation. The inflation was caused by the high oil price and oil shortage. I am not sure about the Latin America since I do not have the detail knowledge about that area. I understand the monetary arguments about inflation. But it seems to work differently today. The loose monetary policy in US seems to have a smaller effect than demand/supply perceptions and speculations. The money are destroyed ang tight in EU while EU's inflation is rising. While i know it is not a simple relationship and it takes time. I just believe that this time, the inflation is more commodity prices driven. The commodity prices are driven by demand/supply or at least the perceptions of demand/supply. By fatbrick - 8/2/2008 4:54 AM

Fatbrick, unemployment in the US began to rise in the early mid-1970s, when US interest rates had indeed increaded, but only in line with inflation. It wasn't until 1979-80 that US interest rates were pushed up sharply as a form of demand destruction. Unemployment soared then, but rising unemployment was a problem through much of the 1970s. As for rising global commodity prices, I have usually heard the blame placed on the very loose US monetary policies of the mid-1960s to early 1970s. In that sense they weren't the cause of inflation so much as its expression. The "cause" was US monetary policy. Of course the argument over what causes inflation is an old and complex one, but I think I am firmly in the monetary camp on this issue. By Michael Pettis - 8/2/2008 2:12 PM

Hi Michael, Some numbers on the loan for you: the PBOC is expected to increase the FY08 Rmb loan quota by 5% (Rmb180 bn) from Rmb3.6 tn, previously, or 0.6% of FY07 loans (c. 0.6% of FY08E nominal GDP). This is expected to be specially extended to SMEs and the agricultural sectors in light of the widely reported operating and cash flow difficulties of many SMEs in the Pearl and Yangtze River deltas. (resource: GS research) Regards, Christine By Christine - 8/3/2008 1:49 PM