International | May 03 2006
By Chris Shaw (Tokyo)
Most experts agree the move by China to lift official interest rates by 0.27% will have little impact on the country’s economy, but few have been as blunt about their view as Morgan Stanley’s Hong Kong based economist Andy Xie, who classed it as a band-aid approach to economic management.
His view stems from his concerns regarding the Chinese property market, where he suggests the sustainable level of demand is far lower than the current level. This means the move to lift interest rates is not addressing the fundamental issue of excess liquidity resulting from a combination of strong export performance and expectations the Chinese currency will be revalued.
The excess liquidity has to find a home and Xie notes the current home of choice is the local property market, with money flowing in as government ownership of the land allows for the speeding up of development, while manufacturing companies are being encouraged to enter the market due to lower returns from their core operations.
Xie compares China’s property market today with the Asian property market experience a decade ago, offering Bangkok in the mid 1990s as an example of a housing boom that became a bust, from which it took some time to recover.
China is now at risk of a similar outcome as Xie notes the banking system is not implementing the appropriate measures to stop the boom becoming a bubble. He suggests a tightening of lending practices is necessary, with a low loan-to-value ratio one step along with measures designed to stop money lent for other purposes being channelled into the property market.
In his view such measures would help as the process is always for banks to lend against collateral and property is the most common collateral used. When money is flowing into the property sector such as is occurring now, this lifts land values and therefore increases the value of the collateral lodged, freeing up more money that subsequently is reinvested into the property sector.
Tightening loan practices in the property market will help, but as Xie notes dealing with the excess liquidity is a broader issue than the property market alone. While China continues to enjoy cost advantages in production he points out this is being subsidised by a lack of attention to issues such as worker benefits, working conditions and the environment.
Addressing these issues would, in his view, result in a normalising of production costs, resulting in a revaluation of the effective exchange rate. At the same time consumption would be likely to increase as income levels would be boosted, the end result being a lessening of the current imbalances in the economy.
Speeding up the process of removing excess liquidity could also be achieved by revaluing the exchange rate, but in Xie’s view a rapid increase would also raise the prospects for a hard landing for the Chinese economy. As a result, he suggests addressing the problem through adjustments to production costs is likely to be a more successful remedy to the current liquidity problem.
