China has increased its Reserve Ratio Requirement (RRR, the amount required to be set aside by the banks, not to be used for lending) yet again...by 0.5% to mop up an additional USD 54 bn from the market with an intention to reduce liquidity and control inflation. Let's take a quick look at the different problems confronting China:
The Liquidity Problem:
Consider this, Chinese banks lent around USD 1.6 trillion (almost equal to India's GDP) in 2010, most of it for infrastructure, and lent almost around USD 160 bn in January alone (!), a figure that's almost twice that of December 2010.
The Inflation Problem:
Inflation in China is already quoting around 5%, according to official figures. I've covered Chinese Inflation issue in my earlier posts, consider reading Betting on China Crash and Understanding China and Japan. Also, while food prices are under control for now, the housing market continues to hog limelight. House prices rose in Jan 2011 in 68 out of 70 Chinese cities surveyed. This, despite the introduction of property tax (though a measly 0.6% to 0.8%) and frequent increases in RRR.
The Currency Problem:
China has been under pressure from various international organizations with sovereign members to let its currency appreciate. Currency appreciation will make its exports less competitive though it might play some part in checking inflation. Currency depreciation will boost its economy but increase the inflation problem. So China has constantly let its currency appreciate, and shows this as compliance to currency non-manipulation to better manage international relations. See the USD Yuan chart below which shows how yuan has appreciated against dollar:
Though the appreciation is there, but its too less, too slow...over the last 1 year, yuan has appreciated by about 4% against dollar.
Soft landing measures:
On the face of it, it looks like Chinese measures are failing to keep both inflation and real estate bubble in check. But just think about it, how difficult would it really be for the Chinese government to dictate terms and functioning to Chinese Banks if they really wanted to curb lending to infrastructure? And please bear in mind, Chinese Banking industry is considered by many investors as fairly opaque and government driven...(part of the reason why Chinese banks don't openly participate (except through proxies) during sale / purchases of various sovereign debt instruments).
China cannot afford to have a real estate bubble crash now...and they know it pretty well. The introduction of property tax also reeks of a gesture to please foreign investors more than anything else. They're completely abstaining from increasing interest rates to avoid a "Yuan Carry trade" situation (read more about this here) which will further worsen the inflation problem. In essence, all efforts are being made to not shake-up the real estate bubble, which has long assumed the position of "too big to fail".
So liquidity control without raising interest rates is probably the best way they've got. And this they're doing not just by increasing the RRR, but even, to a smaller extent, by acquiring Gold mines outside and simultaneously promoting consumption / investment in Gold / Silver in China. So people are just converting their yuan into Gold / Silver, which eventually will go to the owner of these mines from where the metals are being procured...the Chinese government held companies. [This, by the way, is also helping them control inflation through currency appreciation - as yuan supply reduces, it appreciates against its basket of currencies.]
In fact, so strong has the demand been off late, that even China's appetite for Gold and Silver is making frequent headlines. Here's an article from Zero Hedge giving various news items (most of them recent). The result...take a look at the silver prices:
Now, if this is indeed the case, and encouraging gold and silver consumption domestically is indeed a strategy adopted by the Chinese government, it's only a matter of time before both break their all time high and surge further ahead...Now, that's a silver lining in a dark inflationary cloud...
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