China's May CPI is 7.7%, As Expected

CPI inflation came in at 7.7% for May, confirming last week’s “leak”, down sharply from 8.5% in April.  Both the food and non-food components saw a reduction in inflation with, most importantly, non-food inflation declining from 1.8% in April to 1.7% last month.

This should definitely be good news, but the numbers are not terribly consistent with other information.  PPI, of course was up again in May and there are increasing worries and stories about fuel shortages and long lines at gasoline stations.  There has been aggressive selling on the part of the government of food reserves and fuel stocks, and many reports of increased scrutiny of price control mechanisms, even with sharp increases in global commodity prices.  In addition the earthquake in Sichuan not only interrupted food production (Sichuan is a largely agricultural province) but, more importantly, it interfered with transportation lines though the country.  All of this suggests that price increases should continue to be a problem, and a worsening problem, not an improving one.

So I guess I am worried that the reduction in CPI inflation is more apparent than real, and that the “good” numbers will allow the government to believe it has breathing space.  If “breathing space” means that they can relax price controls a little, that would be a good thing, but if it means that they decide they are on the right track in terms of monetary policy, they are almost certainly going to be wrong.  June numbers might not be too bad, although by then they may include some of the adverse effects of the earthquake, but inflation is definitely spreading – even if part of CPI inflation is disguised as shortages, lower profits, or taxes – and food and fuel reserves need to be replenished.  China has little room for another adverse shock.  By July or August CPI should be rising again.

The stock market certainly hasn’t taken heart at the “good” CPI numbers.  It dropped nearly 100 points within the first two hours of trading and then bounced around that level all day to close at 2958, or 2.2% down for the day.  At one point late in the afternoon it traded as low as 2900, before partly bouncing back.

So we have definitely broken the 3000 magic number, and this time for more than a few seconds.  What’s next?  Today’s South China Morning Post had an article claiming that the government is considering measures to support the market, such as the introduction of futures and margin trading, citing an unidentified person close to the CSRC.  I don’t doubt they are considering measures, but I am not sure why either of those particular measures is more likely to push the market up rather than down.  If they do announce either, or both, I suspect retail investors may see it as a positive move without really understanding why.  In that case I expect they will drive the market up temporarily while more sophisticated investors will sell them whatever they want.

Of course if the government doesn’t do anything for a few days these levels will not hold.  Still, they must be worried about how little effect beyond a week or two all of their best previous efforts to hold the market up have had.  As I have pointed out on this blog many times, each failure to intervene successfully, of course, undermines their credibility further, and none of their interventions were likely to be successful because none of them have addressed fundamental investor concerns.

Comments

[James V]

The government has time and time again delayed release of trading futures market because they feared that everyone would sell short and create undelyign fall in the market. So I dont think there is anyway they are really considering this.

If the government introduced margin-stock-trading (well in real terms give opportunity for market participants to BUY stock on margin. I believe this (at these levels) will create strong buying momentum in market.

I believe that the government needs now to open the financial market to the rest of the world. As things stand in real terms the most of the market is just short term gambling. The participants are not sophisticated enough and the market is not being used for its purpose of capital allocation. They need to open the market, speed up giving bank licenses and encourage financial eductation to develop the markets to international standards.

Personally I believe that on a long term basis a lot of stocks are now entering valautions that are very attractive. I believe the market has a bit more to go, but in the month(s) to come a lot of bargains will become apparent. If the market was more open, then the simple situation would create the demand needed for a recovery.

Micheal, what do you think the fundamental Investor concerns are?

Apart from of course their investments losing value as company earnings are being used by the govenrment as subsidy controls to achieve inflation targets rather than curing the route problem caused from the undervalued RMB.

Is there other concerns?

Is the market falling because of outflows from QFII holdings, because cross company holdings are being liquidated or because the everyday person on the street is selling their stock? By company cross holdings I am referring to the holdings created by companies using their company cashflow/borrowing to buy stock in other companies. In developed markets this is know as diversification but in effect in China. Companies were using company money to gamble on the market. It is believed huge positions were amassed.

[huangthomas]

On June 13, the SSE index 1900 was broken. The market was down -88.73 (-3%) to close at 2868.80. Before December 2006, only 30% of stocks are in free float. The remaining 70% are in the hands of government or its agencies. The government started to release the remaining 70% of stock starting 2007 and will be finished in 2009. The market cap will be tripled. Therefore, there is an over supply of the stocks. The government also trying to soak up capital from the market for earth quake re-construction by speeding up IPO of China Construction. Under the circumstances, I don't see any support for the market and the market is still seeking the bottom.