• Wed
  • Aug 20, 2014
  • Updated: 7:51am

Weaker June inflation data may prompt more stimulus from Beijing

Lower consumer inflation and continuing decline in producer price index could prompt Beijing to launch stronger growth measures

PUBLISHED : Wednesday, 09 July, 2014, 10:45am
UPDATED : Thursday, 10 July, 2014, 2:48am

China's consumer inflation cooled slightly more than expected in June, pointing to lingering weakness in the economy which could prompt Beijing to launch further stimulus measures to shore up growth.

The consumer price index (CPI) rose 2.3 per cent in June from a year earlier, down from 2.5 per cent in May, the National Bureau of Statistics said yesterday.

The producer price index (PPI) dropped 1.1 per cent in its 28th straight month of decline, versus a market consensus for a fall of 1 per cent, signalling that demand in the domestic economy remained lukewarm.

"The weak inflation data leaves more scope for Beijing to step up use of targeted measures and even opens the opportunity window for blanket easing policy, such as an interest rate cut, to support economic growth," said Wang Jin, an analyst at Guotai Junan Securities in Shanghai.

Most economists believe Beijing will roll out fresh stimulus measures in coming months to ensure 2015 economic growth meets its target of 7.5 per cent, but they are divided whether it will stick to small-scale measures used so far or take more aggressive steps such as interest rate cuts or a nation-wide reduction in bank reserves.

Policymakers are reluctant to announce a massive stimulus programme like the one adopted during the 2008-09 global financial crisis, which fuelled inflation.

"Subdued inflation means monetary policy will have plenty of room to ease further over the coming months," Julia Wang, an economist at HSBC said in a note to clients. "We think the central bank will likely continue to do so in a targeted manner."

The weaker June inflation reading was mainly due to lower pork and vegetable prices. The CPI fell 0.1 per cent in June from May, versus a forecast of no change in monthly prices. In the first half of this year, average consumer inflation was 2.3 per cent, way below the official ceiling of 3.5 per cent set by the government at the start of the year.

With inflation clearly not a threat for now, the government and central bank have the scope to loosen policies further to bolster the economy.

"Further monetary policy easing across the board will still be needed to help lift confidence in China's economy," said ANZ economists in a research note.

ANZ believes Beijing will reduce reserve requirement ratios for all of the country's banks in the third quarter. So far, it has relaxed the requirement only for banks which are significant lenders to small companies and the farming sector.

Premier Li Keqiang said earlier this week that economic growth quickened in the second quarter from the previous three months. But he added the economy still faces downward pressure.

The central bank said on Monday it would use a mix of monetary tools to keep overall liquidity at an appropriate level.


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One of the goals of the Chinese authority is to double the country’s nominal GDP by 2020.
It’s said that this goal can be achieved 3 years earlier, in 2017.
If achieved, by that time, China’s nominal GDP will be 80 trillion yuan, with a corresponding real GDP of 15 trillion.
M2 by then will be 190 trillion, 240% of her nominal GDP.
To achieve this goal, her average annual nominal GDP growth rate cannot drop below a certain price floor.
To do so, bank credit, the country’s main form of financing, must continuously be supplied by the banks to finance the activities in the economy.
The inflationary pressure so generated can’t be underestimated.
Problem is, unlike before, at least part of China’s domestic savings have become bad.
They are now used to finance the public investments which are no longer self-liquidating, particularly for those high-speed rails and infrastructure projects in the relatively poor western parts of the country.
Without enough population and hence the benefits of economies of scale, those projects will mostly be money-losing, even if their beneficial externalities are taken into account.
Which means some parts of the future GDP figures no longer increase the country’s total wealth.
A more appropriate goal should be to double the country’s national income in ten years.
Higher income means higher domestic consumption, or a higher overall standard of living, which should be part of the goals of any economic reform of any country in the world.
You may already know the Rule of 72.
At an average yearly growth rate of 7.2%, the country's nominal GDP will double in 10 years.
(72/10= 7.2)
Or, 100 x 1.072 X 1.072 ... (ten times) = 200.
So, on average, 7.2% is the price floor of China's GDP growth rate in the coming years.
One may counter argue that China needs to maintain a relatively high GDP growth rate so as to sustain a relatively high employment level in the country.
Well, fast economic growth doesn't necessarily mean a high employment level.
Manufacturing automation or mechanization may spur the growth rate and reduce the employment level at the same time.
Even though the counter argument is true, we have to ask the following question.
Should we employ lots of workers to build a bridge to nowhere, in the name of increasing the country's GDP and maintaining a high employment level ?
Work means useful work, not digging holes for others to fill !
This year, China’s June PPI has dropped year-on-year by 1.1 %.
It dropped for the 28th consecutive month, showing that the pressure of excess capacities at the upper stream of the production river is still there.
The transmission of the pressure to the lower stream of the river partly caused the relatively low CPI figure just released.
The businesses with excess capacities should be weeded out as quickly as possible.
Short-term pain should be substituted for long-term pain to avoid the Japanese Disease.
The deleverage process can promote the industries’ restructuring and upgrading.
But deleveraging will break the capital chain of those businesses.
On the other hand, leveraging up through debt rollover means the banks will accumulate more risks over time.
A better way out is to allow the banks to act as agents, transform the loans of the debtors into shares of their businesses, and sell them to the leading enterprises of the same industry.
This helps to restructure and upgrade the industries which are now suffering from excess capacities, and enables the remaining businesses to become bigger and more competitive.
Also, more capital will then be available at the banks to be lent to the country's SMEs which are sorely in need of lower-cost funds.
The motor vehicle industry in the US began with hundreds of manufacturers, but by the end of the 1920s it was dominated by three large companies: General Motors, Ford, and Chrysler.
If the inflation data are correct, then given the prevalent lending rates of about 14-20 percent (or much higher) in the country's shadow banking market, the real borrowing rates must be very high, and many of the businesses in China have already fallen into the trap of the Ponzi Scheme --- borrowing news loans to repay the old, because even their net revenues are simply not enough to repay the loan interests.
There must be something wrong with China's present credit market.
The country's dominant formal banking system, a form of indirect financing, is no longer sufficient to fund all the financial needs of her real economy.
Direct financing is also needed.
But Shanghai's stock market seems to have lost the full trust of the country's stock investors.
Which means China has to rely more on her bond market than before.
(Chinese readers: ****big5.ftchinese.com/story/001057138)
China’s latest statistical data show that the country’s funds outstanding for foreign exchange (外佔款) has fallen to a very low level recently.
Many factors can explain this drop, but as yet it's not known which of them is the main reason.
Anyway the PBOC may then be encouraged to enact more of her own independent monetary policies, say through targeted expansionary monetary policy of one kind or another.
This is not so desirable, because it means the country continues to depend on the banking system to do the job of scarce capital allocation, a job she doesn’t seem to have done very well in recent years.

It seems that the so-called interest rate liberalization is not a true capital market reform at all.
It is maintained mainly to benefit the banks, through the resulting wider interest margins, and help them to absorb the country's ever-rising bad loans.
True interest rate liberalization should also come from developing a formal bond market in the country --- only when the resulting market-determined yield curve correctly guides the allocation of capital can they say there is true interest rate liberalization in the country.
Despite widespread opinion to the contrary (especially those from the Hong Kong bankers), only after the country has developed a deep and sophisticated domestic capital market should she think of accelerating the efforts of promoting internationalization of the yuan and opening up the capital account.
The cart should be pulled by the horse, not pushed by it.
Without a sophisticated domestic capital market, China can't successfully promote the yuan as one of the world's global transacting, investing and reserve currencies --- yuan internationalization is just cheap talk.
While the recent Great Crisis has turned the US Feb from a good bank to a bad one, it has also created the need for China's public sector to partly absorb the massive debts of the country's private sector, through increasing the leverage of the public sector, by the issuance of central government treasuries and local government municipal bonds.
The country’s massive domestic savings, one of the country’s trump cards, can come to the rescue.
Which means at present China’s businesses and individuals should not be encouraged to invest their excess savings in the foreign countries --- the money should be fully used in her own country.
Some of them seems to be investing heavily in the property markets of the western cities at the precarious top of their property cycles.
It is suggested by the author of the above article that China’s qualified local governments can be encouraged to tap Hong Kong’s bond market, by issuing RMB municipal bonds in the city and allowing them to be freely transacted in the secondary market.
This way, part of the local governments’ coming urbanization projects can be effectively financed, and the bond issuance can be subject to the stricter guidance of Hong Kong’s law and her international capital market.
This also helps propel Hong Kong to the status of one of the world’s global financial centres.
A formal corporate bond market can also be developed in the city to cater to the needs of the enterprises in China.
If so, the present risk of loans offered to the Chinese borrowers by our banks can also be much reduced.
And besides the iBonds, the Hong Kong people, especially the retired elderly ones, will have more investment products to choose and benefit from.
Instead of mainly paying attention to the yuan, our city, facing increasing competition from other RMB swap centres in other cities, should also help our country to develop a formal and deep bond market.
It's said that diversification is the only free lunch under the milky way.


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