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China Becomes Increasingly Shirty, Ahead Of A Rate Rise

International | Jun 22 2007

By Greg Peel

The Financial Times reports the China Securities Regulatory Commission issued new regulations yesterday allowing the country’s 110-odd securities firms and 57 fund management companies to apply for qualified domestic institutional investor (QDII) quotas to invest in offshore securities. Until now, the Shanghai-based Hua-an has been the only fund manager permitted to invest offshore, along with three insurers and eighteen banks. Hua-an has been the pilot program.

Having handed out US$19 billion in quotas to the above institutions, Beijing had hoped to begin recycling at least some of its massive, and continually growing, foreign currency reserves. However, a policy of a gradually revaluing renminbi has made offshore investment less attractive. The local market has been the place to be, with local asset prices surging.

Nevertheless, fund managers are reportedly champing at the bit to invest money offshore, which should generate some more enthusiasm, Beijing hopes. Chinese fund managers had about US$138 billion under management at the end of 2006, and securities firms US$84 billion. The greatest beneficiary of this initiative will be Hong Kong, where Chinese H shares are the only means for foreign investors to ride the Chinese wave. Hong Kong is the obvious recipient of the first tentative Chinese forays into the big bad world.

This is yet another step in China’s attempt to diversify its foreign reserves and reduce its exposure to US Treasuries. April data show China is now a net seller of US Treasuries, and thus a contributor to rising yields. The government also recently set up the US$200 billion Chinese State Investment Company, with a mandate to seek higher risk, higher return investments. The company dived right into the epitome of the capitalist system when it recently agreed to take a big slice of the Blackstone IPO.

In a further attempt to gain some control over the runaway Chinese economy, the government this week announced cuts to export tax rebates on a range of items. Morgan Stanley’s China economist Qing Wang expects that another Chinese interest rate hike (typically 27bps and largely expected) may happen as early as this weekend. A rate hike is never good news for the bubbly Shanghai stock market, but then it would come with no surprise.

Incremental rate hikes are, once again, part of China’s softly-softly approach to controlling its booming economy. As are incremental currency revaluations, the glacial like timing of which are frustrating governments from Washington to Brussels. China pays little heed to such frustrations as it carries on with its own policy measures in its own good time. Any criticism of such is only met with sharp rebuke. The US is simply not, by implication, going to tell China how to run its own economy.

To that end, China issued another pointed warning to the US on Wednesday. It followed an announcement by the International Monetary Fund (International by name, US-controlled by nature) that it would review its framework for exchange rate surveillance for the first time since 1977. The purpose of the review is to expand its coverage (read: interference) to include “all major emerging market economies” (read: China).

In typically subtle fashion, the People’s Bank of China issued a statement on its website suggesting the IMF should “carry out its duties based on mutual understanding and respect” particularly for the views of developing countries, the FT reports. It also suggested the IMF should step up supervision of member states issuing “major reserve currencies that play a pivotal role on the global systematic stability” (read: the US).

In other words, “As far as we’re concerned the IMF can get stuffed – we don’t recognise it anyway – and while they’re at it they can have a look into the Fed’s printing presses”. (Not an FT quote).

Meanwhile, Hank Paulson, US Treasury secretary, hailed the IMF surveillance reform in testimony to Congress yesterday, saying it will “permit firmer surveillance in areas such as insufficiently flexible exchange rate regimes.” He said the US would keep up the pressure on the IMF to carry through on this promise in its actual surveillance work. (That is the FT).

There is currently a bill in Congress that would see exchange rate disputes sent to the World Trade Organisation, treating them as “unfair export subsidies” – a thinly veiled move against China. Beijing no doubt cares little, and probably rates the WTO up with the IMF.

The PBoC has left the world in no doubt that “An unregulated and massive adjustment [of the renminbi] will not only worsen external instability but also influence the sustainability of domestic economic growth, and therefore global growth and the stability of international financial market”.

As China prepares to move into the position of the world’s fourth largest economy, the world’s second largest economy – Japan – has responded to fears that it, too, might begin diversifying out of US Treasuries. Reuters reports Japan’s top financial diplomat Hiroshi Watanabe as suggesting “To diversify right now would have a huge negative impact on financial markets because of the size of our reserves”. Japan may move to diversification sometime in the future, Watanabe added, but only if the US dollar stabilises.

One wonders just how stable the US dollar can remain if Japan is waiting to pounce. There is somewhat of a contradiction in operation there. Japan holds more US Treasuries than anyone else – US$615 billion at last count. Meanwhile, the IMF noted the share of US dollars held in foreign central banks fell to its lowest level in a decade in the fourth quarter of 2006.

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