International | May 18 2007
By Chris Shaw
Even after four years of real economic growth of 10% there are still few signs of inflation in the Chinese economy, which would seem to be a good sign. But in the view of DBS Group the current situation masks a few problems in terms of monetary policy, as eventually the strong growth being experienced will impact on the inflation rate.
Why it hasn’t to date in the group’s view is because the velocity of money in the economy has actually fallen even while the economy has been growing, meaning the effective money supply in the economy hasn’t grown as fast as economic growth would suggest.
Also helping in this regard is companies are using retained earnings and issues of shares to finance growth, meaning there is less dependence on loans from banks. Certainly the retained earnings are substantial, as profits from the top 5000 companies in China have increased from 2% of GDP in 1999 to around 9% in 2006, this despite a stronger exchange rate against the US dollar and tighter monetary policy measures instigated by the People’s Bank of China (PBOC).
World Bank figures indicate as much as 20% of Chinese GDP is accounted for by corporate savings and DBS estimates these retained profits are financing as much as half of corporate investment.
The most obvious impact of this is a likely reduction in the rate of credit growth, something the group sees as a good thing given it will improve the stability of the banking system.
The problem though is the investment is already and will continue to feed into higher asset prices, which eventually will flow through into higher inflation. This means the series of tightening measures already put in place by the PBOC are pre-emptive in nature, but on DBS estimates policy remains too loose and interest rates are too low when compared with asset prices.
This leads it to suggest further tightening in policy is all but inevitable, its current forecast calling for a further two hikes in rates of 0.27% each before the end of the year. (Goldman Sachs has penciled in three such interest rate rises).
The group suggests the risk of further hikes remains to the upside given the potential for inflation to push higher, but cautions even further hikes may not be enough to stop the frenzy that is the growth in some asset prices.
