In China Administrative Measures Trump Market Measures, For Now

In a sign of how worried the authorities are about rising speculative inflows, in a report released Thursday SAFE said it would step up the monitoring of foreign capital inflows.  Yesterday I wrote about the policy paralysis that seems to be occurring as different groups within the government have some fairly radically different ideas on what are the biggest problems facing China.  Under the circumstances, I argued, it is very hard for those who are worried about inflation, overheating, stock market excesses, and speculative inflows to organize the consensus needed to take the rather more dramatic steps China needs to take.

 

That was not completely correct.  Where policy paralysis seems to be occurring is actually in deciding what appropriate market measures need to be taken – adjusting the currency, raising domestic interest rates, liberalizing the markets, or relaxing price freezes.  There does not seem to be a lack of consensus – or perhaps it is more appropriate to say that a wide consensus is really not needed – when it comes to administrative measures.  The government continues to use administrative measures and various forms of signaling in its attempts to address the stock market and inflation, and it seems that its first weapon of choice with which to attack hot money inflows is likely to be attempts to strengthen capital controls.  That is how I read the SAFE announcement.

 

Clearly greater vigilance on this front is likely to have some impact on capital inflows at the margin, but I think there are at least three problems.  First, by now it seems that speculative inflows are so large that reducing them by a little is not likely to create a whole lot more breathing room for the PBoC.  Although many commentators are only now starting to concede that hot money is a big problem, the fact is that it almost certainly was a problem even a year ago.  Given the nature of these inflows it is hard to get a real sense of how rapidly they have grown, but one Chinese commentator claims that inflows this year are running at three times last year’s pace.

 

I have no idea if this is true, and certainly can’t prove it one way or the other, but even if he is way off, I think few of us who have been trying to estimate the numbers would argue that hot money inflows have not increased dramatically, and we all agree that they are now a much more serious problem.  In that case, it would take a very large reduction to “fix” the problem, and I don’t think increased monitoring is going to have that impact given how complex and large China’s trading and investment networks are and how easy it is for agents to skirt the law.

 

Second, this increase in monitoring will necessarily raise the cost of legitimate transactions, and very tight monitoring might seriously hamper economic activity.  Trade is important to China, as is FDI, and the bureaucratic delays and frictional costs associated with a step-up in monitoring may have a significant economic cost.  Finally, most of the empirical evidence suggests that in a developing economy with weak governance an increase in monitoring will deepen illegal channels and strengthen corruption.  This can’t be in China’s interest.

 

So China’s fight against hot money will be like its fight against inflation and its fight against stock market volatility.  Instead of market measures it will first try a variety of administrative measures. I think this fits more comfortably within the intellectual and cultural framework with which the leaders are most familiar and it gives the sense of managing the process in a non-disruptive way.  If it ends up having no effect, as I think it won’t, the consensus will gradually build for more realistic measures.  The problem, of course, is that this may take much too long.

 

On a separate, but related, note, one of my former students who has spent the past three years as a trader sent me the following (edited) note:

 

There has been market talk that CIC is placing USD deposit with onshore banks (both local and foreign).  one-year onshore USD is quoted at L+900 bps, so it’s economically correct for CIC to do so.  This is the main reason why onshore FX swaps are bought up at -6000 to -2600.

 

Personally I think this is real, but I am not able to find out or even guess how much money they lent out onshore.  The onshore banks will have to place a bigger amount of USD reserve with PBOC, but I am not sure whether this will have any impact on the FX reserve number

 

Another thing, in reference to the rapid growth in USD loans onshore in the first quarter that you discussed on May 18, I checked with several banks, and many of them tell me that the corporates are borrowing USD and swapping the USD into CNY thru fx swaps, to get CNY funding.  (Following a query the student told me that these corporates are swapping with the banks that lend them USD.).

 

Let’s see if I understand.  Corporations are borrowing US dollars from local banks and then swapping into RMB.  Why?  I guess that this allows them access to RMB funding without, technically, taking out RMB loans, which would come under the lending cap.  Logan, if you’re reading this, what do you think?  Does this fit with what you are hearing?

Comments

[huangthomas:]

Chinese government has decided not too raise interest rate again, but to control the lending, because almost all major banks are state owned. Now you are beginning to see and learn Chinese wisdom. As Chinese like to say:

Sky is high and the Emperor is far away,
You have a rule, and I have a way.......

2008 Jun 08 12:49 PM

[rainman:]

Governor Zhou is so lack of creativity, other than raise BRR each month.
China, like Canada, has the housing bubble burst ahead and that is why they dare not hike the rate, or their banking system wold suffer.

Catch 22 by following a catch-22 empire.

Learn ECB or Bank of Australia, at least they don't have conflict goals, and read Fischer Black's Legacy on CAPM, short SNP.

2008 Jun 08 02:23 PM

[J.D:]

Huangthomas, do you know of any financial institution in China that is not state-owned? I don't.

2008 Jun 08 09:35 PM

[James Lewis:]

Sounds like a major split in party policy to me, the government (or part of it at least) has left the USD channel open on purpose. This is a lending allocation method so that only the bigger, smarter companies can get funding. Smaller companies quite often do not have facilities/knowledge/c... within banks to borrow in USD and convert into RMB.



Chinese Government Policy always has a backdoor, and 9 times out of 10 it is on purpose. This is why in China only the fittest survive.

Sky is high and the Emperor is far away,
You have a rule, and I have a way,
But the emperor is happy with my way
Or he would not have given me the opporutnity.

2008 Jun 08 11:22 PM

[M. Pettis:]

Huangthomas, I think too often we assume that if the government does something amined at achieving an objective, that is the same as actually achieving the objective. It isn't always the same. The government has placed loan caps in order to slow loan growth. This seems to have limited loan growth in the commercial banks, but as I wrote last week, if you include the increase in loans by policy banks and the increase in foreign currency loans, neither of which come under the loan caps, total lending has actually inceased (and this does not include the likelihood that underground banks have also seen a great deal of loan growth). In other words the government's policies sometimes only address the problem in theory, and not in fact. I think this is because they have failed to understand the fundamental monetary problem and think they can tinker with solutions. But over the past three years none of their "solutions" has had any effect.

JD, China Merchants Bank is not government-owned.

2008 Jun 09 08:20 AM

[Daniel K:]

This blog post even comes with witty comments, couplets, and retorts. Great.

2008 Jun 09 09:49 PM

[J.D:]

I understood the China Merchants Bank is owned by the China Merchants Group, an SOE.

China Minsheng is often cited as a private bank, but it has close connections with Shanghai and Beijing government officials, which may render the "non-state" distinction largely academic in terms of influence/control.

2008 Jun 10 06:24 AM

[M. Pettis:]

JD, the distinction is often hard to make between some or mostly public ownership (most companies directly or indirectly) and state-owned or controlled. It is a safe bet to assume that few large companies in China do things that the government does not want.

2008 Jun 10 07:48 AM

[J.D:]

Yes, I'm sure they do, but then ministries and agencies do as well. The difference between all of them isn't very clear. Thanks again for the bonus comments.

2008 Jun 10 01:14 PM