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Entries in China (5)


And the award for EM safe haven of choice goes to ...

... China!

At least this is the conclusion from some fascinating number crunching from JPMorgan's Flow & Liquidity team in their report last week. I had a feeling that this was the case looking at the surge in Chinese FX reserve growth (capital inflows) in the past 6-12 months, but it is still interesting to see such clear evidence from the data.

Here is F&L on the outflow data;

(...) around $80bn of capital left these 22 EM economies [read: essentially EM ex China and the Middle East] cumulatively since last May. This $80bn outflow is likely understated by $20bn due to the 1.6% decline in the dollar between the end of May and end of February, as a weaker dollar pushes up the dollar value of non-USD denominated reserves. Adjusting for this leaves us with around $100bn of estimated capital outflow from these 22 EM countries between May and February.

This estimate of $100bn worth of EM outflows since the tapering scare began in May/June last year is not the controversial number. The main question is then where the money went and here it gets very interesting.

This capital outflow does not necessarily reflect capital leaving the EM universe as a whole. In fact it seems that China, perceived as safe haven, has attracted a similar amount over that period. Using similar calculations of FX reserve changes adjusted for current account flows, we arrive at a $125bn cumulative capital inflow into China between May and December, as the outflows of last May/June more than reversed in subsequent months. Of this $125bn figure, around $25bn reflects the 2% decline in the dollar between the end of May and end of December. This leaves us with around $100bn of estimated capital inflow into China between May and December.

What is particularly interesting about these numbers is that the breakdown reveals that only a small fraction of this, $20bn according to JPM, reflects net FDI. The rest represent so-called hot money flows in the form of portfolio flows and short term flows into demand deposits (to take advantage of sharply higher interest rates in China).

With the CNY just having seen its strongest bout of volatility in a long time last week it may seem rather inopportune to publish a note on the inexorable and inevitable rise of the CNY. Personally, I would be wary taking the consensus view at face value here. In fact, on many accounts the CNY looks overvalued here and this is exactly what the market is also telling us I think (at least in the short run). CNY volatility and weakness are also the two main markers I would be watching for signs of capital outflows and ultimately how China could become a big headache for the rest of the world. 

All this however does not detract from the fact that JPM gets the completely unofficial award this week for the best sell side data crunching exercise. The tapering scare that emerged last summer has been linked to all kinds of bad outcomes for emerging markets as a whole. Clearly, this is not an accurate description and something which investors should not lose focus of.


China Moves Towards More Easing ... 

Update: Here comes the confirmation with a poor flash PMI for March. From Markit; 

“Weakening domestic demand continued to weigh ongrowth, as indicated by a slowdown in new orders whichcame in at a four-month low. External demand remainedin contraction territory, but the decline was at a slowerpace, implying that there are no improvements in thedemand outlook. More worryingly, employment recordeda new low since March 2009, suggesting slowingmanufacturing production was hindering enterprises'hiring desire. The soft-patch in manufacturing was in linewith the recent downside surprise in industrialproduction growth. Growth momentum could slow downfurther amid a combination of sluggish export neworders and softening domestic demand. This calls forfurther easing steps from the Beijing authority.”


This may be a targeted and essentially pinpointed move, but looking at the data coming on China in the first quarter of 2012, I think there is plenty more to come as China tries to come to grips with a rapidly slowing economy. 

Quote Bloomberg

China boosted rural credit by cutting reserve requirements for an additional 379 branches of Agricultural Bank of China Ltd. (601288), the nation’s third-biggest lender by market value.Effective March 25, the ratio falls by 2 percentage points for the branches in the provinces of Heilongjiang, Henan, Hebei and Anhui, the People’s Bank of China said in a statement on its website yesterday. The move expands a trial that previously lowered requirements for 563 branches in eight provinces. The latest move means a total of 23 billion yuan ($3.6 billion) has been freed up, the PBOC said.

Money supply growth has effectively stalled in China and with the recent statement by BHP Billiton that Chinese steel output had flattened what they really meant was that they are now seriously concerned about a severe and lingering slowdown in China. Of course, there are considerable details that must be taken into account here. However, one thing that we must understand is that production capacity (supply) of hard commodities may turn out to have structurally overshot demand even in mighty China. 

So far, we must give Chinese authorities the benefit of the doubt and it is almost certain that they will now turn from a focus on inflation to a focus on growth. This is particularly the case as inflation has come down significantly in China and while base effects will be an important part of this story, the sharp retrenchment of liquidity will also have mattered. 

In my view, markets are likely to turn to growth in the next months where disappointing data out of China and the US are likely to put a dent in an otherwise strong rally. 


Random Shots - High Expectations

If investors were hoping that the strength of commodities was sign that decoupling, led by Asia and Latam, were running on course to help the global economy expanding, events last week must surely have extinquished such hopes. Indeed, it was always a question of commodities and emerging markets catching up to the ongoing slaugther in Europe. 

Indeed, what seems to be main question now is whether the US economy will avoid a recession and, as a consequence, just how bad it has to get before the Fed starts another round of shock and awe QE. In this sense, I also always thought that expectations of emerging market foreign exchange reserves bailing out Europe and/or central banks easing aggressively to support the global economy were pinned on expectations that after all were too high. 

(Quote Bloomberg)

The world’s largest emerging economies will not act as a bloc to ease Europe’s financial crisis, Russian Deputy Finance Minister Sergei Storchak said.“It’s impossible, I’m certain of that,” Storchak told reporters today in Washington. “If the BRICS are going to act to overcome the euro zone’s financial problems, then it will be based on the possibilities presented by working through the International Monetary Fund.”Finance ministry and central bank officials from Brazil, Russia, India, China and South Africa met before this week’s IMF annual meeting to discuss coordinating policy as Europe reels from a sovereign debt crisis and growth slows in the U.S. There is a “high” danger that Greece will not fulfill all of its debt obligations, Storchak said.

As for the EM tightening cycle I think that while we may certainly see an easing of pace or perhaps even a full stop of tightening measures I think a reversal is out of the question. This is the case even if the recent strong correction in commodities and the global slowdown is likely to make inflation a non issue going forward. The point is that inflation lags the cycle and if the central banks are fixed on this measure it will take some time before the data allows decisive action unless of course the future is suddenly discounted in a radically different way due to rising downside risks. 

In India, the tightening cycle is surely near its end with the yield curve already flat as a pancake, but with sticky inflation and fiscal policy continuingly loose, there is limited scope to the central banks' ability to manoeuvre.

(Quote Bloomberg

India’s central bank is close to the end of its record series of interest-rate increases as inflation will probably slow next year, Deputy Governor Subir Gokarn said.“You could say that the cycle is nearing its end,” he said, “given the projection that inflation will start coming down and will continue to move down from December onwards.” He declined to specify when the Reserve Bank of India may stop raising rates.

Worryingly, recent news out of China appears that the country may be turning Indian or at least that easing may not come quite as expected. Especially, it is bad news for the global economy in the near term (but perhaps good in the long run?) that Chinese authorities seem to be engineering a crack down on property developers which will not only lead to an acceptance of lower growth in order to effectively quell off balance sheet lending. 

It seems that investors hoping for emerging markets to drive forward the global economy may, for the moment, be guilty of too high expectations.