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Friday, October 29, 2004

Already, since I just had a few cups of baijiu and am in the middle of nowhere in Hebei, I am yet again in a self-congratulatory mood. As seen in my last posting, I did sort of predict this rate hike. I attach a pretty excellent article from the Washington Post on this topic. The article is good, but I must take issue with Professor Lang's assessment that this rate hike is bad.

This rate hike is on a whole a good thing. As he pointed out, it will not affect money supply too much, since it is such a small movement. While it might have hurt the stock market, it will not hurt the private sector by much either. The main rationale for this rate hike is to pre-empt an out-flow of RMB from the banking sector and from China itself. As the Caijing article (cited in my last post) pointed out, there was a significant movement of RMB from the banking sector in the past few months due to negative deposit rates. If inflation continues even at the mild rate of 5 or so %, you still have a negative deposit rate of 3%. This will prompt an outflow of RMB from the banks in search or other lucrative opportunities like the stock market and the real-estate market. This is why in the past month, despite a modest increase in money supply by 13%, you still have strong fixed asset investment. A rate hike is necessary to slow the outflow of RMB from the banks, and I suspect more hikes are to follow. The rate hike will not affect enterprises which want to borrow from banks, but will affect real-estate developers who want to raise money directly from investors.

If the PBOC raises interest rate by another 75 basis points in the following months, nominal deposit rate will rise to 3% and inflation should fall below 4%. It still makes for slightly negative real interest rate, but is a lot better than the situation today. There will be much less private capital sloshing around in the real-estate market. Granted, Professor Lang has a point that money invested by private investors might be more efficiently allocated than money loan out through banks. However, banks are better (major borrowers are no longer local governments but central government and large joint-stock firms), and it isn't clear if real-estate and the stock market are the most efficient way to allocate capital. The entire financial market is problematic in terms of efficient allocation.

So, with the baijiu running through my system, I dare to predict that there will be three more 25 basis point movements upward in the next three months.


Washington Post

China Touches the Brakes With Higher Interest Rates By Peter S. Goodman and Paul Blustein SHANGHAI, Oct. 28 -- China's central bank raised interest ratesThursday for the first time in nearly a decade, signaling a deep uneasewith the breakneck pace of development and an intent to curb aconstruction boom that is sowing fears of runaway inflation. The unexpected announcement by the People's Bank of China drove down oil and commodity prices, as well as the stocks of mining and metalscompanies worldwide, with the expectation that China's voracious appetite for raw materials will wane as its economy tightens. The bank yesterday raised its one-year lending rate by 0.27 percentagepoints, to 5.58 percent, effective Friday, while rates paid to depositors in Chinese banks would go up by an equal margin, to 2.25 percent. By itself, the increase amounts to a trifle, a marginal bump thateconomists said would have little if any immediate impact on the overalleconomy, now growing at more than 9 percent a year. But analystsconstrued the announcement as a clear signal that China's leaders areintensifying efforts to cool the economy when a surfeit of new factories, office towers and residential development has outstripped the supply ofraw materials and energy. Some expect more increases in coming months asthe central bank seeks to slow new investment. "This is the beginning of a long tightening process," said Dong Tao,China economist at Credit Suisse First Boston in Hong Kong. "The economymust be slowed because it's currently running at an unsustainable level." U.S. officials praised the interest-rate increase as a sign that Chinais relying more on market forces to guide its economy and may be speeding a plan to let its currency move more freely against the dollar. China now maintains a fixed exchange rate that U.S. and European officials feel iskeeping the cost of its exports artificially low. "This is a change in the direction of things that [is] very promising -- a more market-oriented financial system, monetary policy and ultimatelythe flexible exchange rate," John B. Taylor, the Treasury undersecretaryfor international trade, said in an interview on Bloomberg television. Only a few years ago, the movement of interest rates inside this stillnominally communist country was of little consequence to the rest of theworld. But China is now by some measures the world's second-largesteconomy. Its growth has fueled a surge in demand felt from the iron-oremines of Brazil and Australia, the cotton and soybean farms of the U.S.Midwest and the luxury-goods-makers of Europe. China's purchases ofmaterials such as palm oil and rubber are now the single largest sourceof economic growth in much of Southeast Asia. Its hunger for steel andmachinery has played a pivotal role in lifting Japan from years ofstagnation. China's thirst for oil -- it is the world's second-largestimporter -- is among the key factors driving up the price of that commodity. Yet even as markets adjusted to the prospect of a China slowdown,economists noted that the increase in interest rates is virtuallyinsignificant in itself. "The impact on the real economy is going to be as close to zero asanything," said Jonathan Anderson, chief economist at UBS InvestmentResearch in Hong Kong. Anderson said the increase is important as asymbolic gesture aimed at persuading depositors to keep their money inChinese banks. With interest rates unchanged for years even as inflationclimbed past 5 percent, worries have set in that China's savers arepulling their money out of banks to seek better returns in speculativeinvestments such as real estate. The state press has carried reports of a growing black market as companies with cash to spare lend it to privateentrepreneurs at higher rates of interest than banks are allowed to charge. Central bank officials have also openly fretted about the prospect ofan overheating economy -- growth so fast that it leads to high inflation. In recent months, the government has been trying to gradually ease growth and avoid a so-called hard landing, a sharp drop that could closebusinesses and throw people out of work. The root of the problem is visible in any Chinese city. As construction cranes dominate the horizon, the price of everything needed to fashion an office tower continues to climb. Shortages and bottlenecks abound. Ships wait weeks to unload atovercrowded ports. Rail and road links are overwhelmed. In most of thecountry, electricity is in short supply and being rationed, forcingfactories to limit production. With so much new money cycling through the system and urban incomesrising, prices of meat and vegetables have leapt -- a boon to farmerswhose incomes have long stagnated, but a source of worry that China'spoorest people are suffering. Concern mounts that if real estate prices unravel during a buildingglut, the banks that have lent in support of the speculative frenzy willbe saddled with billions of dollars in bad loans, adding to a tally nowestimated by private economists to be about $500 billion. As such worries intensified earlier this year, China's leaders soughtto tame growth through administrative fiat. They imposed curbs on newloans into the hottest sectors of the economy -- in particular, steel,cement and auto manufacturing. But while those measures have had some effect, inflation has continuedto climb. In its statement, the central bank declared that theadministrative curbs had "achieved good results," but that a rateincrease was required "to address recent conflicts and problems, and tofurther consolidate the results achieved." The last time China raised its benchmark lending rate, in July 1995,growth slowed by nearly half, plunging to 7.1 percent in 1999 from nearly 13 percent in 1994. One economist, Larry Lang, chairman of the finance department atChinese University of Hong Kong, said the increase was misguided. Thelargest borrowers in China have traditionally been local governmentsspending money on major public-works projects, and state-owned firms kept alive to preserve jobs, he said. If interest rates are higher, thosesorts of borrowers will continue to draw credit, regardless of theirability to repay their loans, Lang said. Meanwhile, China's emergingprivate sector, increasingly the source of new jobs and profitablebusinesses, will have a more difficult time getting its hands on credit. "This is a very stupid move," Lang said. "It won't affectover-investment, but it will hurt the private sector and it will hit thestock market." Others were skeptical that the rate increase has any broader effect onissues such as the exchange rate. Nicholas Lardy, a China specialist atthe Institute for International Economics, noted that Beijing has lowered interest rates several times over the past few years without changing its currency policy. "This time could be different, but I think the idea that this move somehow presages something on the exchange rate is putting thebest possible interpretation on it," Lardy said.

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Monday, October 25, 2004

A reporter asked me some questions about interest rates. Will it rise? Who knows, but I think on a whole it is less costly to raise it now.

Have there really been no changes to China's interest rates for the last
seven years, as has been widely reported? Or just no RISE in interest rates?

I have to look it up, but interest rates have changed on the margin many
times in the past seven years. For example, deposit rate for bank
deposits at the PBOC and relending rates have increased a couple of times
within the last year. The PBOC website should have some information on
that. Some lending rates have also increased recently. When they talk
about interest rate increase now, they are mainly talking about
increasing rate on working capital loans and deposit rates.


Why hasn't the PBOC raised interest rates as they said they would back in
May if the CPI in China went above 5%?

I suspect there is some opposition to that from coastal provinces, which
want to continue a higher pace of investment. In truth, China has seen
inflation much worse than 5%, so technocrats in Beijing thus far have not
had a strong argument for raising interest rates by a lot. Also, the
Ministry of Finance has enjoyed really low interest rates for bond
issuance, so they would vote with the low interest crowd at policy meetings.

Isn't China's effective interest rate at about zero or actually negative
and doesn't this encourage speculative behavior?

Yes, there is negative real interest rate for bank deposits now, and
many depositors are withdrawing money to speculate in the real estate
market. According to the Caijing piece, there has been a loss of
100b from the banking system in the past 6 months from people withdrawing
money from the state banking system. Granted, 100 billion is not a big
deal, but this can explain why fixed assets investment is still
relatively high despite the fact that money supply only grew by 13% in
the last month. In other words, the new investment now is fueled by
withdrawn bank deposits, not bank loans.

Is an interest rate rise imminent?

I am not sure at this point. There are some good reasons to do it, and
some reasons not to do it. As I indicated above, different parts of the
government have different interests. However, now that the central
committee plenum is over, I think they are more likely to raise interest
rates than before. It wouldn't be a huge increase, however. If they do
it, they will raise lending rates for working capital and deposit rates
at about the same magnitude to ensure bank profits.

What would be the negative effects to the economy, if any, if China were
to raise interest rates now?

I don't think it will have much of an impact on the economy if interest
rates were raised by 1 or 2 %. the PBOC has in effect put a quantity
limit on lending already. Raising interest rates will encourage some
depositors to put money back into the banks, but I don't think it will
have an impact of more than a few hundred billion RMB.

How would the banks be affected by a rate rise?

Again, banks will lobby on a higher increase in lending rates than
increase in deposit rates. Usually, they won't get their way, and
lending rates will only rise by just a bit more than deposit rates.
However, given that CCB and BOC plan their IPOs soon, the central
government might be more generous with the banks.

How much freedom do banks have to set interest rates at present? How are
they controlled?

Very little control, the PBOC now sets a band that all banks in China
must adhere to. The band now is, I believe (check this), 50% above the
PBOC rate. In other words, if official rate is 4%, banks can charge up
to 6%. The Chinese government continue its control over interest rates
so that it can use interest rates as a policy tool to benefit various
regions, sectors, and policy areas.

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Friday, October 15, 2004

Now that you have suffered through my self-congratulation, back to some cynical observations:
The SCMP reported a mini item, which is much more interesting than its space allotment suggests.

SCMP, 10/15/04
"China Petroleum & Chemical Corp's (Sinopec) parent Sinopec Group has agreed to buy a 5.67 per cent stake (five billion state-owned shares) in Sinopec from China Cinda Asset Management for nine billion yuan in cash and a 7.08 per cent stake (6.14 billion state-owned shares) in Sinopec from China Development Bank for 11.05 billion yuan in cash."

What is going on here? Why is Sinopec buying Sinopec shares from Cinda, which is a state asset management company, and from the China Development Bank? Is Sinopec trying to reduce shares outstanding? Basically, this is a classic outcome of command economy inter-bureaucratic bargaining. But they are buying and selling shares, you say. Well, you have to understand that Cinda and CDB acquired those shares through debt-to-equity swaps in the first place from non-performing loans. Essentially, in 1998, the Premier of China ordered Cinda and CDB to acquire a mountain of non-performing loans. One way to deal with these NPLs is to convert them from debt to equity, which magically transform these distressed assets into performing assets in the books of Cinda and CDB. The problem of course is that most beneficiaries of d-e swaps can't pay any dividend since they are broke. Not so the oil companies, however.

Cinda and CDB probably knew that NPLs from oil companies aren't so bad and demanded a share of oil NPLs among the mountain of NPLs they acquired. The State Council (the Premier) brokered a deal with all the agencies whereby the asset management companies and CDB would acquire some pretty good assets (oil shares) and a lot of very, very bad assets. Because of high oil prices, this deal probably worked better than expected. Now, Cinda and CDB are asking for the pay-offs, which is an injection of oil profit from this year into the books of Cinda and CDB. CDB hardly needs it since it is the best run bank in China, but Cinda, which is stuck with a huge mountain of worthless assets, can really use the cash injection. This cash injection will boost the "cash recovery ratio" of Cinda and make everyone in the NPL policy area look good, including the AMCs, CBRC, and MOF.



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A bit of self-congratulation. My wife certainly won't let me do it at home, so I can only do this in my own blog. Earlier, State Administration of Foreign Exchange Chief states that greater fluctuation of the yuan should not affect employment rate. This shows, however, precisely that the current administration is concerned about the employment impact of a yuan revaluation. (increasing the trading band now would essentially revaluate the yuan to the limit of the band). Well, that was my guess in a previous posting.

SCMP
Friday, October 15, 2004Stronger yuan 'may not worsen jobless rate'Forex chief predicts strengthening currency would not affect exports either
REUTERS in Beijing
Prev. Story Next Story
Fears that a stronger yuan would increase unemployment are probably overstated if the exchange rate moves in a controlled range, the foreign exchange chief said in comments published yesterday.
"If the renminbi's exchange rate fluctuates in a controllable range [that is, managed floating], it will not have a major influence on domestic employment," Guo Shuqing , the head of the State Administration of Foreign Exchange, said.

A "managed float" is Beijing's term for gradual reform that many analysts expect will be based on widening the yuan's slim trading band.
Mr Guo also played down the effects of a stronger yuan on exports, saying the mainland's competitiveness came from low labour costs, not a cheap currency.
But he said the impact on jobs would be considered as part of formulating policy.
"When considering the exchange rate policy, we will also think about its potential impact on domestic employment," Mr Guo, who is a vice-governor of the central bank, told the China Daily newspaper.
His message was in line with pledges to slowly ease controls on the yuan, pegged at about 8.28 to the US dollar and which is not freely convertible.
On Tuesday, Mr Guo's administration poured cold water on mounting speculation the mainland would strengthen the yuan soon, saying it would not resort to a one-off revaluation.
It has resisted pressure from the United States and others to strengthen the value of the yuan, with officials saying that such a move would, among other effects, throw many people out of jobs at a time when unemployment was already high.
They fear a stronger yuan would make mainland products more expensive and possibly lead to a slowdown in demand for exports, which have boomed in recent years, helping to create jobs.
Beijing is also worried that a shift in currency policy could have unpredictable consequences as authorities try to cool heated investment and lending and put the world's seventh-largest economy on a more stable footing.
But US Federal Reserve Governor Ben Bernanke said yesterday that a move toward currency flexibility by China would benefit the mainland and global economies.
"Moving toward exchange-rate flexibility is in the interest of China as well as the rest of the world," Mr Bernanke told a Washington conference. An independent monetary policy and freely floating currency would give China an economic "shock-absorber", he said.
He played down concerns that a shift in China's foreign exchange regime could dent the US bond market if Beijing stopped being a buyer.

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Wednesday, October 13, 2004

I have been preoccupied with buying a car; finally decided on a Buick Regal, which happens to be a Chinese government approved model for government cadres. I guess it was fate.

The first item of interest is that the State Development Bank might take over NPLs from regional banks in the Northeast, repackage them, and sell them to someone. First of all, you can bet that Chen Yuan, the head of SDB, is fighting tooth and nail against this. The SDB has worked extremely hard in the past decade to keep its books in tip-top shape. Under Zhu, Chen managed to resist pressure to use the SDB to fund state construction projects. Zhu had to push that task on to commercial banks like CCB and ICBC. Now the Wen administration (the whole NE revitalization policy is Wen's policy "innovation") is trying to push the prize of NPLs from the northeast on to Chen. With Zhu retired, however, Chen might not be able to resist this time, especially given that Shang Fulin, who sees banks as policy tools, will soon take over the CBRC.

At the end of the article, it seems that the AMCs will also acquire part of this "prize." In fact, I think a major acquisition of NPLs by the AMCs seems likely in the near future. Bureaucratically, AMCs are the weakest players and are highly susceptible to policy intervention from other agencies. I bet that SDB will fight to acquire only the best NPLs or will take over only a small chunk of NPLs, while AMCs will once again end up with the lion share of NPLs. But I think this time around, SDB attempt to maintain the cleanest balance sheets in China will falter as more and more policy tasks are heaped on it.

SCMP
Wednesday, October 13, 2004
BAD LOANSBank to acquire northeast NPLs Plans to repackage bad debt stem from greater flexibility for financial institutions
ELAINE CHAN Next Story
-------------------------------------------------------------------------------- China Development Bank is considering a plan to repackage non-performing assets worth hundreds of billions of yuan as part of Beijing's drive to revive the country's ailing northeastern provinces. Officials from the State Council Office for Invigorating Northeast China's Industrial Bases said the plan emerged from a policy granting more flexibility to the region's financial institutions.
"It is being studied and co-ordinated with relevant government departments," Wu Shiguo, deputy general director of the agency, said yesterday.
Mr Wu was in Hong Kong as part of an investment delegation from Heilongjiang.
The plan was first hinted at last month, when vice-minister for the agency, Song Xiaowu, said the CDB might take over regional NPLs and re-sell them at 15 to 20 per cent of book value. The bank would be empowered to acquire bad assets from regional commercial banks and state firms at a discount and bundle them for resale, greatly reducing the amount the original lenders would have to write off.
CDB announced earlier this year that it would offer a 10-year, 71.5 billion yuan line of credit for the northeast provinces of Liaoning, Heilongjiang and Jilin.
CDB officials could not be reached for comment.
Officials from the revitalising northeast China office said they were co-ordinating with local governments, the People's Bank of China and the China Banking Regulatory Commission on a more flexible policy for NPLs.
By the end of August, NPLs in the region totalled 405.33 billion yuan. Banks in the three provinces maintain a bad-debt ratio of 31.44 per cent - 16.78 percentage points higher than the national average, according to CBRC figures.
A number of pilot schemes for managing China's NPLs have emerged in recent years. The Industrial and Commercial Bank of China (ICBC) is selling NPLs worth billions of yuan back to state firms at a discount in an experiment that helps the banks write off bad debt while firms get to settle accounts.
"The variety of methods to resolve NPLs is greater and the channels to sell them increasing," said Su Xihe, general manager of China Huarong Asset Management Corp's department overseeing the northeastern and eastern regions.
Since Huarong's establishment in 2000 to manage NPLs for ICBC, the firm has taken over 81.1 billion yuan of non-performing assets from the northeastern rust-belt. It had disposed of 21.99 billion yuan of these as of the end of July.
Mr Su said they would be taking over assets worth a "considerable amount" from the bank soon.


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