China remains a key market but we need to consider how the Chinese government is managing the curren...
China remains a key market but we need to consider how the Chinese government is managing the currency with regards to the large inflows of foreign capital (in other words, revaluation). Also, we need to look at what the considerations are before the Renminbi (RMB) becomes fully commercialised.
China's market is open for current account transactions involving trade in goods and services but the capital account is basically closed, save for FDI and a small range of borrowing, lending and asset transactions. This helps protect China from so-called 'hot money' flows.
The government has started to tighten up on inspections of FDI but non-FDI flow, or private capital flows (in other words, hot money) keeps penetrating in various guises. RMB revaluation would be one way to settle this issue if it is significant enough to allay expectations of further revaluations. An alternative would be to move to a completely free float system. Thus far, the government has refused to give way on the RMB peg, concentrating on banking reform and economic stability. We are unlikely to see a totally unrestricted currency in the short to medium term, but cannot rule out a limited shift in the peg or a move to a basket of currencies.
Another consideration is the existence of a Chinese property bubble and whether or not the bursting of this bubble is anticipated, similar to the experience in Japan in late 1980s and the internet bubble of the 1990s. There are some similarities between China and the US in this regard. Property prices have risen in most parts of China but the only area that it appears 'bubbly' is in Shanghai. Shanghai is the obvious choice for foreigners who want to own property in China, used by many as a way to get exposure to the RMB so they can bet on revaluation. In most other Chinese cities, housing remains affordable for the average person. It is the strong demand created by fast-rising household income that is mainly driving the real estate boom, along with wider use of mortgage financing, rapid urbanisation and speculation from overseas buyers. Evidence of speculative demand in the big cities, particularly Shanghai, does question whether the volume growth of real estate sales is justified by underlying real demand.
Stability in the country's financial system is key to avoiding a hard landing of economy. The government would probably not institute large interest rate hikes this year because default rates for mortgages and those loans on overheated sectors might get higher. The government might tend to use structural administrative regulations and only mild interest rate hikes to control the possible overheating problems.
High commodity prices are applying a strong margin squeeze on many industrials, so the government has not needed further austerity measures. Expansion plans are being trimmed back, and the focus is now on reducing costs and more efficient use of resources. The likelihood of China getting severely overheated again is slim, more likely is a mild slowdown.
Property bubble emerging in China.
Government unlikely to raise interest rates sharply this year.
China economy faces mild slowdown, not overheating.
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