International | Jul 26 2006
By Chris Shaw
Last week the People’s Bank of China (PBOC) lifted the reserve requirements for the Chinese banking sector, the latest in a series of attempts to cool the pace of growth in an economy that for the June quarter showed a rate of increase of more than 11% year-on-year – in plain English this is probably best described as hotter than anyone can handle, including the Chinese.
Some, such as Bank of America and JP Morgan Chase & Co, have taken the view the latest tightening will flow through into all sectors of the economy and so produce the desired slowing in economic growth. Consensus estimates are for the economy to post overall growth for 2006 of 10.4%.
But others like Morgan Stanley economist Andy Xie suggest more needs to be done globally by central banks to counter the emergence of inflation. ABN Amro belives the PBOC must do more to show it is serious about slowing China’s economic growth, as a failure to do so could damage not only the domestic economy but the global economy.
Goldman Sachs agrees, pointing out measures to control the rate of lending tend not to be effective for long when an undervalued currency encourages continued inflows of foreign exchange, which remains the case in China as evidenced by its reserves of US dollars reaching about US$940bn as at the end of June.
ABN Amro suggests China’s growing trade surplus is all the evidence needed to show its economy needs rebalancing, as it gives a clear sign the relative prices of goods and services remain too low in China and so must rise.
It points out such an increase can come in one of two ways, with either an appreciation in the nominal exchange rate or an increase in inflation within China. Given monetary authorities seem determined to maintain the exchange rate peg at artificially low levels, this leads the broker to suggest the risk is a breakout in China’s inflation rate. This would eventually push up the price of China’s goods and services relative to the rest of the world, likely slowing global economic growth given the low price of goods from China has allowed consumption in economies such as the US to remain strong.
In ABN Amro’s view the small rise in the Chinese currency to date is nowhere near enough, so forcing the PBOC to continue to intervene in global foreign exchange markets and via the acquisition of US dollar denominated assets such as Treasury Bonds.
It also means the domestic economy continues to expand strongly, so there is still the risk of bubbles forming in some sectors of the economy such as the property market as overinvestment continues. The end result in the broker’s view is more severe policy measures may be required down the track, with such an outcome unlikely to be good for either the Chinese or global economies.
