China has earned well-deserved praise for the meticulous efficiency with which the Olympics has been conducted so far. But, the same cannot be said of its economic policy. With the Olympics in Beijing at the halfway stage, it is time to ask questions about post-Olympics China. Would it pursue an economic growth rate of around 10% or settle for 8%? Would it believe inflation has been tamed or is further monetary tightening in store? Answers to these would determine the outlook for commodities that have declined in price substantially in recent weeks, as well as the outlook for Asian inflation and economic prospects in general.
Recent economic data and decisions should be cause for concern to the rest of the world. Last week, China’s inflation, trade, retail sales and industrial production numbers were released. On the face of it, China’s inflation rate had peaked. The annual inflation rate had slowed in the last two months from nearly 9% to just above 6%. However, producer price inflation at 10% took a lot away from the relief generated by the CPI (consumer price index) inflation data that was widely flagged. Internal contradictions in the economy are coming to the fore. Price controls for coal, oil and electricity are creating disincentives for free flow of inputs at all levels of the production chain. In fact, over the weekend, China demonstrated its continued penchant for economic quick fixes as it raised export taxes on coking coal. The ostensible purpose is to address the coal shortage for power plants.
If price controls on inputs (coal and power, to name just two) are relaxed in the coming months to ease shortages, inflation would raise its head again in China. The current stance of not tightening monetary policy or not allowing faster currency appreciation would then become untenable. For now, the contradictions are held in abeyance and export growth picked up strongly in July. Annual growth in exports surged to 26.9% from 17.6%in July. It is hard to say, based on one month’s data, if this is the beginning of a sustained rebound in exports.
Much of it could be front-ending of August exports due to anticipated Olympics-related shutdowns. We need data for August and perhaps even September to conclude whether the export rebound would be sustained. Yet, it is already impressive that a month-by-month comparison with 2007 shows that China’s exports have done better in 2008 in every month up to July. Of course, dollar prices for China’s exports have increased in the last year due to the appreciation of the Chinese currency against the dollar. So, there is a bit of currency effect in these export growth numbers. Yet, exports are still rising at too fast a clip to be attributed solely to currency effects. The implications are not positive for China or for the world.
If China’s export growth remains brisk, in spite of slowing global demand, it must be at the expense of other nations’ exports or the importing countries’ domestic production. That has protectionism risk written all over it. Second, it has implications for commodities prices, particularly base metals and crude oil. They would rebound and raise inflation questions all over again for the world economy. Third, it would put the spotlight on China’s decision to slow yuan appreciation due to the recent dollar rebound and exporters’ concerns.
Many US economists who don’t hesitate to judge China’s currency as undervalued and its one-sided intervention as manipulation have problems in believing that revaluing the currency would solve the global economic imbalance. They may be technically correct. In their framework, the exchange rate is endogenous. But, for many of us, the exchange rate policy is not. It is both deliberate and exogenous. There is unlikely to be a shift towards an accent on domestic demand in East Asia unless the yuan exchange rate issue is addressed. That is the starting point, for sure, although it may not the only thing that matters.
Economic imbalances in China are the cumulative outcomes of policy choices in the last 15 years. They need time to be whittled down. But, the near-total removal of appreciation expectations for the next year for the yuan in the non-deliverable forward market is not an encouraging sign of change. It confirms status quo that does not accord well with the need for weaning the economy away from reserve accumulation, undervalued currencies and export dependence.
The problem for the rest of the world is that China is now bigger than it was about 15 years ago, when its decision to devalue the yuan sowed the seeds of the Asian crisis — its decisions or non-decisions have global impact. The China risk is yet to be factored into global asset prices.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org