Hong Kong and China: How Will Inflation Affect Their Economies?

Includes: EWH, FXI, PGJ
by: Enzio von Pfeil

Excerpts from Dr. Enzio von Pfeil's May 22, 2008 appearance on CNBC Asia:

  1. Oil prices spiked to a new record above $129 a barrel, fueling fears of inflation and its impact on consumer spending and corporate profits. What is our outlook on HK's April CPI out at 1615 on May 23rd?
    • April’s annual inflation rate will exceed 4%.
    • Food as well as fuel prices are the headline drivers.
    • Another one is that the ever-weaker dollar is driving up “imported” inflation: we have to pay more HKD per unit of Australian dollar as well as Euro. The ever-stronger Euro, for instance, is driving up the costs of clothing and footwear imported from Europe.
    • This increase in fuel prices is terrible for transport-related companies. Indeed, bus fares have been hiked, but as these hikes have to be approved by our Executive Council, the government does not allow the bus companies to pass on fully the fuel cost rises.
    • Meanwhile, airlines like our Cathay Pacific have the constraint of fighting particularly with European airlines, so Cathay cannot just pass higher fuel costs on, either: with the bulk of their income in Euros, European airlines are paying “less” for fuel than Cathay is.
  2. HK Q1 GDP grew 7.1 pct year-on-year, versus 6.7 pct growth in the previous quarter. Growth in the first quarter exceeded economists' consensus forecast of 6 pct. What is your outlook on the HK economy?
    • According to The Economic Clock™, The Economic Time™ in Hong Kong is characterised by an:
      • Excess supply of money, and by an
      • Excess demand for goods.
    • However, with inflation eating away at peoples’ incomes, view this as a macro tax hike. This means that disposable incomes shrink.
    • Besides, we for one do not believe that the U.S. sub-prime mess is over by a long shot.
    • Nor is The Economic Time globally so great.
    • Add to this China’s current woes, and our outlook is not bright – nor is it dim.
    • The “props” will remain fixed asset investment and government consumption.
    • The “drags” increasingly will come from weaker, although still robust private consumption (which drives up inventories), and weaker exports.
  3. Inflation in China reached 8.5% in April, all but ending the Government's hopes of containing it to the 2008 target of 4.8%, this coupled with more inflation worries following the devastating earthquake in Sichuan on May 12. How would China's inflation affect HK & the rest of Asia?
    • Before I answer, it is vital to understand the nature of global inflation: it is of cost-push nature, heralding stagflation.
    • So, inflation is driven primarily by:
      • A weaker dollar, fueling America’s import costs,
      • Rising agriculture prices, thanks to La Nina and previous planting policies, and
      • Rising metals and minerals prices, fueled by strong, sustained demand from India and China, but also by supply issues – ranging from the policy of the oil cartel to mining strikes in South Africa that drive up the price of platinum.
    • The same story applies to China.
    • As it is costs, not demand, that are driving inflation, the government – the Central Bank – cannot do a great deal.
    • Yes, it will allow the RMB to keep rising against the dollar, in order to contain imported inflation – but remember that the RMB is not rising so strongly against other currencies such as the Euro and Australian dollar!
    • I am less concerned about how China’s inflation will affect the rest of Asia; of greater concern is how its poorly-performing stock market will affect sentiment in Asia (see next).
  4. Anything else you want to highlight?
    • Picking up on my last point: corporate profits in China are threatened by two “gales”:
      • First, rising costs that cannot be passed on. This applies particularly to oil refiners, but also to airlines faced with global competition, and
      • Secondly, companies are having to face increasing losses on their stock portfolios.
    • This “double header” will crimp companies’ abilities to create jobs or indeed make more fixed assets investments.