Policy paralysis

According to today’s 21 Century Business Herald, Chen Donqi, vice president of the Academy of Macroeconomic Research (research arm of the NDRC), has warned that China needs to take steps to avert the risk of a sharp economic slowdown, including “pro-active” fiscal policies such as reductions in corporate and personal taxes. On the other hand two days ago China Daily reported a release by the PBoC’s Institute of Finance Research that rejected warnings that a sharp decline in exports are likely to lead to a hard landing for the Chinese economy. The research institute also said that although the recent earthquake would add to inflationary pressure, its effect was likely to be temporary. Nonetheless the PBoC should not relax its current “tight” monetary policy.

That seems pretty much to represent the split in policy-making. Various agencies, experts, and government officials make announcement to the press that seesaw back and forth between worried warnings about monetary excess and equally worried concerns about economic slowdown – with the export sector screaming loudest, even though overall exports are still growing sharply. The NDRC and other groups, such as those in the Ministry of Commerce, are worried about a slowdown and want to see steps taken to prevent any significant reduction in economic activity, while analysts around the PBoC and many of the top universities are worried about massive hot money inflows, see rising inflation as a real concern, and want to continue running a tight monetary policy (although, as I have many times written in this blog, I think monetary policy is anything but tight).

There is developing a strong consensus that May CPI inflation numbers are going to be sharply down because of declining food prices, although the real thing to watch now is the non-food component. If the problem is too much money, and not too little pork, we should expect to see an inflation “valley” as renewed food production takes short-term pressure off CPI inflation, but as excess demand is no longer fully absorbed by rising food prices, it will quickly shift to other goods and services, and inflation will surge again. Of course if the problem is too much pork, food prices should begin to drop permanently while non-food prices remain stable.

If May CPI inflation drops below 8% year on year, as many expect it to (April came in at 8.5%), I think it is going to be very hard for the monetary alarmists around the PBoC to take control of the debate. There are many reasons to think that we are going be strongly biased towards the relaxation side for the next month or two – a benign inflation number, the need for earthquake relief, and continued worries about global demand for Chinese exports. If oil and food shortages become a problem, or if the non-food component of CPI surges, it will be harder to make the case for relaxation.

I think the most important thing to watch over the next few months is hot money inflows. They have probably been massive for several quarters now, but the last six months or so have been, as far as we can tell from the evidence, simply extraordinary, and I can’t think of any way these inflows can be managed domestically without causing serious damage to the country’s financial system and balance sheets.

Meanwhile the stock markets are inching closer to the 3,000 level, around which most participants believe the government will intervene. It hasn’t traded with much conviction one way or the other – today it bounced around several times within a fifty-point range before closing the day down 0.54% at 3352, a scant 12% from the perceived intervention level. Driving the market are worries that price controls, especially on steel and coal, are going to hurt profits. At this point the market clearly believes that there is inflation in the system, and they understand that price controls (and subsidies) convert inflation from CPI increases into higher taxes and lower corporate profits, and they are reacting.