China: Money Keeps Pouring In

The RMB broke through 7 today. This is pretty much a non-event, in my opinion, but it was treated as a symbolic milestone and some accounts claimed it had psychological importance. Since the rapid increase in the RMB is a pretty well-established trend by now, I think the only thing that will make me sit up and notice is if it suddenly gaps upward overnight.

Much more interesting was the news about the trade surplus and FDI. The trade surplus for the first three months of the year was $41.6 billion ($19.5, $8.6 and $13.6 billion for January, February and March, respectively), versus $46.3 billion in the first quarter of 2007. This is the first time the quarterly trade surplus has declined in three years.

Some commentators are suggesting that this decline in the trade surplus is evidence that the credit-related measures to slow the economy and the rising RMB, combined with the global slowdown, are finally having an impact on the trade account. I am not sure I agree. First of all it is still not clear whether the full impact of the January storms has worked itself out of the numbers.

Second, and more importantly, for all the worry about how a rising RMB would cripple exporters (and it hasn’t really risen except against the dollar), Chinese exports in fact grew by a very healthy 21.4%. It is only because export growth has been so phenomenal recently that 21.4% seems like a small number, but it is in fact a very big increase for such a major exporter, and as Chinese exports increasingly dominate their markets it becomes statistically more and more difficult to maintain earlier growth rates. This “reduction” in the growth rate of exports has nothing to do with the rising RMB or slowing world growth.

Imports grew by 28.6%, and high oil and commodity prices may have accounted for a big chunk of this growth. According to Mark Williams at Capital Economics, the higher oil bill took out $10 billion in the first quarter of 2008 relative to the same period last year. Strip this out and we may well see that domestic consumption growth is still not keeping up with production growth – i.e. the trade surplus, which is the gap between the two, would have increased.

What was particularly interesting was what happened in the FDI account. According to the numbers released today, FDI for the first quarter was $27.4 billion – nearly 73% more than the $15.9 billion recorded last year over the same period. So although the trade surplus declined by $4.7 billion, it was more than matched by the $11.5 billion increase in FDI.

This means that without even counting other net inflows – most especially hot money inflows not accounted for in the trade and FDI numbers – the increase in central bank reserves continues to grow beyond even last year’s unbelievably high numbers. Remember that January and February reserve growth were (even with the possible $22 billion underreporting caused by the redenomination of bank minimum reserves) the two highest monthly numbers on record, and I suspect that the total increase in reserves for the first quarter of 2008 will be a whopper.

We are now caught in the most mechanical and frustrating part of the monetary trap in which China has been caught during the past five years. The trade surplus was the original driver of China’s out-of-control money growth, but by now the growth seems to have taken a life of its own as money piles into the country seeking to take advantage of the nearly-inevitable run-up in the value of the currency. Hu Xiaolan, the head of SAFE, said that SAFE and the Ministry of Commerce are going to investigate whether FDI has become a channel for hot money inflows. Hmmm, I wonder.

On perhaps a related note, Xinhua reports today that China’s external debt increased over 2007 by 15.7%.

China's foreign debt reached $373.62 billion at the end of 2007, up 15.68 percent over the previous year, the State Administration of Foreign Exchange (SAFE) announced on Wednesday. China's medium and long-term borrowing totaled $153.53 billion;at the end of last year, an increase of $14.17 billion, or 10.17 percent, according to the SAFE.

Meanwhile, the country's short-term borrowing increased $36.46 billion to $220.08 billion, up 19.85 percent. Of the total external debt, $34.89 billion was the sovereign debt; foreign invested enterprises accounted for $74 billion; and the amount for foreign financial institutions in China was $46.31 billion.

Preliminary statistics showed all of China's foreign debt indices were under the international standard safety line in 2007, the SAFE said.

I don’t really have much information about the reason for the $50.6 billion increase over the year, and of course there is no way to discern the impact of this borrowing on the country’s reserve position without knowing to what use the funds were put (i.e. were they spent in China or abroad?), but the practical trader in me assumes that even with the easy domestic-currency borrowing conditions it still makes a lot of sense for Chinese companies to fund as much as possible from abroad. China’s external debt levels are miniscule given the country’s size and, more importantly, reserves, but foreign borrowings are one more source of domestic money growth.

Meanwhile the NBSC has revised upward GDP growth for 2007. It turns out that because of underreporting of growth in the services industry, including telecommunications and retailing, China’s GDP growth for 2007 was actually 11.9%, not 11.4%. We would like to see services comprise a bigger part of the economy, and this revision is welcome for many reasons.

Comments

[James V]

The problems of the snow storm extended well into late March at some factories due to raw material delays. There were also a lot of manufacturing delays due to staff shortages and new staff at factories. Firstly a lot of migrant workers were delayed going back to their home towns so they stayed until later in the year than normal. Also The Migrant workers use Chinese New Year as their time to change jobs. They know they can get jobs very easily and the factories dont pay enough/ treat them well enough most of the time for them to stay. So they change jobs a lot expecially this time of year. This year there was a lot of this behaviour (inflation comes to mind).

I think the surplus figures were very very strong considering the storms, time of the year and global slowdown. In fact I think it adds to arguement RMB appreciation and credit related measures (ha ha) aren't working. Whats more I think that shortly there will be a wave of manufacturers putting up their prices. As foreign companies have little in the choice of alternatives, I think they will stomach the price increases in general and this will actually keep surplus climbing.

I believe that as long as there is not huge political fallout from Tib and other issues at hand the FDI will start to accelerate upwards. Of course if I was China I would give the impression that there was infact some political instability to stop huge FDI increases occuring while I re-valued the Yuan up. It would not surprise me if they adopt this strategy albeit in a more subtle way. For sure there will be a number of policies aimed at curbing hot money coming into play in the very near future.

[Dan Harris]

I can vouch for this from an extreme micro level: my law firm has seen no slowdown (if anything, we have seen an increase) in US companies wanting to set up operations in China. The strangest thing is that not a one of them has even mentioned the political climate there as in any way inhibiting them. It is a complete non-issue.

[the US and China Today blog]

Its really nice to see these type of articles at Seeking Alpha. Many of us do not follow or have access to these type of information because we are not in the financial industry.

We will be channeling our readers over here from time to time.

[J.D]

It will be soon apparent that this FDI is not in fact FDI but hot money seeking to take advantage of the RMB appreciation, bolstered by the knowledge that inflation will keep interest rates high. Make money on the fx, make money on the i differential, all backed by big fx reserves and the certainty that China is incapable of serious financial market reform. These flows are a warning sign, not an indicator of confidence.

[nickgogerty]

any thoughts on stress among the peasants, rising food and capped fuel prices could increase stress in the countryside.

[J.D]

Google Yang Chunlin for some info on rural tensions, also migrant laborers aren't the most satisfied bunch in China. Even so, the r/e bust won't be a good story for them, nor would a broader economic slowdown (think lots of work and no pay). Fuel shortages and price controls, as well as made-in-China and global inflation, are adding a lot of uncertainty to the mix. More wealthy individuals have certainly been hit by the stock market decline, though the bulk of the pain there will likely fall to SOEs. Add riots in the west and a related crackdown, plus a highly charged nationalistic atmosphere before the big Olympic show and things are looking pretty interesting at present.

[the US and China Today blog]

Expect some of this money to then pour into Taiwan though.

"China-Taiwan relations on the upswing?"

www.uschinatoday.com/u...