My Blog

August 25, 2008

The Olympics are finally over, and with a spectacular ending that reportedly had Jimmy Page performing “Whole Lotta Love”.  I didn’t see the performance – I was in a park just south of the Olympic Stadium with three friends, trying to get a glimpse of the fireworks – but I am definitely curious to know what the very prim leadership were thinking as the guitar chords crashed about and as someone (presumably) screamed out “Wanna give you every inch of my love” (although perhaps in deference to the local leaders they skipped the vocals). 

Whatever the fate of the Olympics, the up-and-down struggling in the stock markets that characterized the Olympic period is certainly not over.  On Friday, the last trading day of the Olympic period, the SSE Composite declined by 1.1% to close at 2405, which brings a net loss of just over 11.8% for the SSE Composite since August 8, the day of the Opening Ceremonies.

Today, the market bucked the trend (sort of).  After a quick downward break in the first half-hour of trading, the market recovered and was pretty strong for most of the day.  The best performers were the banks, who have been reporting good earning growth.  In the last hour of trading, however, on admittedly weak volume, the market suddenly gave up most of its gains, with the SSE Composite closing the day at 2414, up by just under 0.4%.  The Shenzhen markets did not do as well, and most Shenzhen indices ended the day down by 0.4-0.5%.

I spoke to various friends in the market to get information on what has been driving trading, but it was hard to get a sense of strong conviction either way.  Economic numbers are ambiguous, and I think most participants are hoping for some sort of fiscal stimulus, while at the same time dreading that it won’t make much of a difference anyway.  I think there is also a lot of nervousness about a psychological post-Olympic let-down.  After all the anxious excitement of the Olympics, with the constant, non-stop coverage in the press and on television, there will be little left of the color and excitement and a lot of work repairing the disruptions.  I don’t know when and how the many migrants and poor who were ejected from the city will return, but I would guess that their welcome will be muted.  Meanwhile we have been getting sporadic press reports about the cost to farmers within the region of the Olympics water policies.

The main thing is that now that the Olympics are finally over, we should quickly return to a less colorful reality, and policy-makers and analysts will get back to trying to figure out what the next few months are going to look like.  Today there was confirmation of sorts of the fiscal stimulus package reported last Tuesday in a JP Morgan note.  One of the most widely read of local financial periodicals, the Beijing-based Economic Observer, had an article in today’s paper citing unnamed sources who claimed that the CPC’s Central Financial Leading Group had put together a fiscal plan to support a faltering economy, although this plan had yet to be revised by the Ministry of Finance or approved by the state Council.  

According to the summary of the article on the newspaper’s website (which, by the way, seems to mistake the JP Morgan note for a “Morgan Stanley report”):

A market report stating that high-level Chinese officials were considering a 200 to 400-billion-yuan economic stimulus package has led to temporary surges in stock prices and debates amongst economists. Though no forthcoming official confirmation since the Morgan Stanley report was released on August 19, the EO learned from sources in the Ministry of Finance that an "expansionism" formula was under study in case the economic growth slowed further.

The proposed formula might include 150 billion yuan of tax incentives and 220 billion yuan of additional expenditures, mainly to be spent on public facilities and services. Some held that the Chinese market was still growing healthily and that such interventionist measures were unnecessary.

If there really is such a program and if it is executed, and the newspaper cites an unnamed MoF official who claims that the proposal would have to go through many more stages before it became policy, the total fiscal stimulus would amount to a little under 1.5% of GDP.

Meanwhile Gregor Neuman alerted me to an article in today’s ChinaStakes.  According to the article, in July, for the first time since 2003, tax growth has experienced a dramatic decline:

According to Ministry of Finance (MoF) statistics, China’s total revenue in July was RMB 532.325 billion, an increase of 13.8% over the same month last year. But this growth rate is 19.3 percentage points lower than in July, 2007, and 19.7 percentage points lower than the growth rate in the first half of the year.

The article goes on to say most sources of tax revenues showed sharp declines in growth rates, with corporate income tax actually down 4.2% from last July.  Comprising RMB 149.6 billion of China’s total tax revenues of RMB 5323 billion for July (28%), the decline in corporate income tax was credited by the MoF to:

a decline in companies’ performance. Between January and May, profits of industrial firms with annual sales revenue of more than RMB 5 million increased by 20.9%, a growth rate 21.2 percentage points lower than in the same period last year. Due to RMB appreciation and raw material and energy price hikes, in the first half of the year about 65,000 small and medium-sized enterprises went broke.

I haven’t looked at these numbers beyond the ChinaStakes article and I am very far from being any kind of expert on the fiscal revenue and expenditure side, but I do think it is worth noting that these numbers seem extremely volatile.  I have mentioned several times in the past my concern that the surge in tax revenues over the last four years has been more than matched by a surge in fiscal expenditures, but I suspect that if something were to diminish or even reverse revenue growth (an economic contraction, perhaps?) it might not be quite as easy to slow expenditure growth in line with revenues.

As if to comment on my concerns, the article goes on:

Professor Liu Heng of the Central University of Finance and Economics said the tax decline would likely continue due to the economic slowdown but would not largely affect fiscal expenditure. On July 8, the MoF warned departments to be ready for pressure on spending in the coming year. In the first half, budgeted income of local governments was RMB 1.526521 trillion, and the budgeted disbursement was RMB 1.806929 trillion, showing a deficit of RMB 280.408 billion.

Meanwhile, tax from land and real estate, a major source of the local governments’ incomes, has also declined drastically. In July, land-related tax increased by 79.4% over the same month last year, for a total of RMB 14.306 billion, but this was 25 percentage points lower than in July 2007.

Land transfer income has also decreased, due to the real estate market doldrums. This income should have been included in the government’s budget but, in fact, has not been, so the budgeted incomes of local governments don’t represent their real income level.

Liu Heng thinks the tax decline “won’t be a big problem”, since China has put a certain amount of money from its tax income every year into a rainy day account.

Perhaps. Unfortunately, as the saying goes, when it rains, it pours.

As an aside, on Saturday the South China Morning Post published the third of my biweekly “Money Matters” column.  This week’s column was about foreign currency reserves and why they cannot be part of any fiscal stimulus package.  You can read the article here.

Comments (12) for "Making sense of what comes a...

"In July, land-related tax increased by 79.4% over the same month last year, for a total of RMB 14.306 billion, but this was 25 percentage points lower than in July 2007. " I did not read the original news. But this seems not to make any sense. By fatbrick - 8/25/2008 12:25 AM

“Wanna give you every inch of my love” was changed to “Wanna give you every bit of my love”. The female singer fretted that the original lyrics would not make a great deal of sense. By Dwyfor Evans - 8/25/2008 10:08 AM

i read you article in scmp, similar argument you have before in this blog. the point is if the reserve is spent in RMB denominated economy, the chinese central bank is the ultimate buyer, so the net reserve will not change. however, if the reserve is spent in international market. those reserve will ultimately go to other central banks's balance sheet. in that case, those reserve can be used to exchanged for physical goods from outside and use them in chinese infrastructure build out. now that you may argue that those reserve are not central banks real wealth, they are the borrowed money from chinese people. i agree. that is what those reserve initially come from. however, if central bank make money from the money borrow, then the money they made are the real wealth. image that i borrow 100 RMB and put it in the A share market. of course, the initial 100 RMB is not my real wealth, i need to pay it back when the lender demand it. However, i was such a genius at 2006-2007 and I made RMB 1000 out of those initial 100. so, my real wealth is 900=1000-100, assumed that i borrowed interest free. i have some similar examples posted two days ago. but it seems that no one was interest to explore that further. By outlier - 8/25/2008 10:43 PM

Michael- does SCMP own the copyright to your article? I'm not registered. By sharpe_mind - 8/26/2008 12:32 PM

Outher, if most of the PBoC reserve accumulation was from interest income, you would be right, but most estimates of PBoC income assume that they earn about 4% (or maybe a little less) on their holdings, and these estimates have been informally confirmed or guided by PBoC officials. This year reserve growth was equal to an annualized 35-40% of total reserves, suggesting that most reserve growth (perhaps 90%) comes from the purchase of foreign currency. This purchase must be funded. Reserves can be spent abroad of course, but there is little difference between the government's borrowing RMB and buying reserves from the PBoC to purchase oil, and the PBoC's purchase of oil directly, which it then "donates" to the government. In either case net domestic debt increases -- in the first case MoF debt and in the second PBoC. No matter how you do it, any money spent by the government must come for somewhere. By Michael Pettis - 8/26/2008 3:05 PM

SM. Email me and I can send you a copy of the article. By Michael Pettis - 8/26/2008 3:07 PM

Fatbrick, I think they mean that the previous year it had increased by 105%, whereas this year it only increased by 80%. The language is a little tortured. By Michael Pettis - 8/26/2008 3:36 PM

i agree that interest income is tiny comparing to total reserve. however, not matter how tiny that is, it is something that PBoC's real wealth and they can spend it. Now that if they find better investment opportunity, the return can be upper single digit like 7-8%, that could make a huge difference. the real puzzle is this. those people exchange foreign currency for RMB can usually get a much better return than 7-8% annually. think about those QFII, 100% return in 2006-2007 is not unusual. So that, someone come to PBoC with $100 at the begining of 2006 and exchange for 800 RMB, then by the end of 2007, this guy as 1600 RMB at hand and want out. The PBoC at this time need to come up more $200. even that, people like paulson want the exchange rate to be 7:1, 6:1, so RMB 1600 can be like $250. Well, how does the PBoC come up with that kind of cash? it could only have $105 from investing those $100 in T-bills. so, why do china want QFII? By outlier - 8/27/2008 2:35 AM

Michael: Could you comment on the article below? Beijing swells dollar reserves through stealth http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/26/ccchina126.xml By Alex - 8/27/2008 7:16 AM

In one of your earlier posts you mentioned the fact that FAI has surged in the first seven months to July 2008, up some 27% compared to last year. This would indicate a future surge in industrial production. How can this be reconciled with this fear of a sharp slow-down of growth in China? I am reading more and more commentary lately, on various blog sites mostly U.S., that sugests that a slow down in China's economy is all-but-certain. Some of this is clearly intended to bury the decoupling and re-install the snezze and catch a cold idea. By Alfred - 8/27/2008 10:11 AM

Outhier, I am not sure that assumption that an investment in the Chinese stock market usually yields 100% is a good one. In fact most investors in the Chinese stock market in 2007 and 2008 have lost money, QFII or domestic. By the way even if every non-government investor in China's stock market sold his shares tomorrow and immediately took his money out of the country (and even if the stock market stayed at today's levels and did not crash from all that selling), there would still be more than enough reserves to accomodate it. The stock market is just not very big. Alex, this is an old story, one that I have been writing about since October of last year. Between transfers to the CIC and redenomination of minimum reserve hikes, headline reserve growth has been less than net inflows of foreign currency by $100-200 billion. I am not sure I agreee with the journalists conclusion that this accoutns for recent dollar strength. Alfred, the slowdown, if it happens, would affect domestic and foreign consumption of Chinese goods before it affected production. I expect we will contiinue to see production surge, but if this production is not pruchased by Chinese consumers or exported, the result will be an investory build-up that will evetually lead to a cut in inevstment. By Michael Pettis - 8/27/2008 3:45 PM

If the CCP does undersell the majority of its dollar assets in its foreign reserves, it will result in global economic chaos. Although Secretary Paulson of the U. S. Treasury said China, being the second largest holder of U. S. treasury securities, possesses less than the daily trading volume of these securities, Paulson had to give this confidence talk as a political figure. What Paulson said is true. However, once the underselling starts, through the exaggeration of media reports, the international“ hot money” ... By forexbacktestingsoftware.com - 9/21/2008 5:30 AM