From 18 May, the nation’s biggest lenders will have to set aside cash to a record 21% against their liabilities, in China. The People’s Bank of China (PBoC) made this announcement on Thursday. The question is whether one should praise the resolve of PBoC to engineer low inflation or should one discuss the risk of hard landing in China. Of course, there is also the third possibility of whether this resolve is being shown too late and in the wrong place.
In my public comments in the course of 2011, I had maintained that it did not matter if Asia did not perform well this year in the stock market sweepstakes as long as Asian governments did enough to secure their long-term future by battling inflation resolutely. On that measure, both the central banks in China and in India are showing a lot of resolution. That should make their assets a good long-term buy at current levels.
Also Read | V. Anantha Nageswaran’s previous columns
However, in both cases, we need to look deeper. One, no matter how much resolve they show, the problem of inflation is not going away partly because its resolution is not entirely in their hands. It has got to do with US monetary policy.
Yes, commodities prices have become volatile lately and have declined. That is good news. But the bad news is that fundamental forces are very much acting to constrain rather than expand their supply. Second, even though the US dollar has been strengthening in the last few days on account of mild risk aversion in financial markets, it is not certain that it would be a lasting trend. The US Federal Reserve is soon likely to signal its determination to root out any trace of slowdown and/or deflation once signs of wobbly economy and/or waning risk appetite become more widespread.
So, under this global backdrop, notwithstanding their resoluteness, the central banks in India and in China would be called upon to do more as 2011 winds its way to a conclusion. Simply put, they are not in a position to announce the conquest of inflation.
The other concern, in China, in particular, is that much as PBoC raises reserve requirements on big banks, it has also begun to acknowledge that the forces of credit creation are spread out far and wide in the economy. That is why lately it has begun to track a metric called “Total Social Finance”. Hence, even now, it is impossible for us to know the extent of credit creation that PBoC has to tame.
Paul Cavey of Macquarie Securities has been doing an excellent service by sharing translated versions of articles that appear in Chinese local language press on the tightness of financial conditions in China. The preface to his latest instalment of such service is self-explanatory:
One of our recent translations detailed how a private company defaulted on its loans from private lenders. This week’s excellent article from the 21st Century Business Herald suggests that story is far from being a unique case. Indeed, against the backdrop of monetary tightening, private-sector financial stresses seem to be becoming more of a theme. Today’s article also confirms what we heard on our own visit to Wenzhou a few weeks ago: curb market rates have risen to record highs. Another common element to the stories of tight private-sector financing is the impact on the formal financial sector. Obviously, this is important: apart from gradually slowing down the economy, monetary tightening might also start to impact the overall financial system. (source: www.21cbh.com/HTML/2011-5-11/1MMDAwMDIzNzU1MQ.html)
That raises the spectre of an economic hard landing in China. Interestingly, while a few economists had begun to downgrade their growth assessment for India in the fiscal year 2011-12 (ending March), consensus real economic growth outlook for China in calendar 2011 gathered by Bloomberg Finance Lp, has not budged an inch. It remains at 9.5%. That appears increasingly untenable.
The underperformance of Indian and Chinese stocks has snuffed out the nascent recovery in Asian stocks that began in March, after the sharp decline in the first two months of the year. Over the last three weeks to a month, US and European stocks have done better. Unfortunately, in the near term, this might continue much as it is both unsustainable and undesirable. It is undesirable because it stems from US loose money policies and hence jeopardizes geo-economic cooperation. The “Free Exchange” hosted by The Economist might have given the game away when he wrote:
“The thing is, as many difficulties as the American economy faces, it’s hard to think of large economies in more enviable circumstances.” (www.economist.com/blogs/freeexchange/2011/05/global_growth)
The US might be succeeding too well in its policy of exporting inflation to the emerging world and diminishing their investment appeal, for its own good.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com