China likely to raise interest rates, keep yuan stable in 2005 -Morgan Stanley
Wednesday, January 12, 2005 4:42:40 AM
afxpress.com
HONG KONG (AFX) - China is likely to raise interest rates gradually this year while keeping its currency stable, as this approach carries the lowest risk to the country's economy, Morgan Stanley said. Andy Xie, managing director and an economist for Asia-Pacific at Morgan Stanley, said this is one of four policy scenarios that he foresees in China this year. A gradual increase in interest rates will enable China to deflate its property bubble, slow fixed investment and diminish speculative pressure on the yuan, he said. "When China's economy has landed, demand for yuan will reflect reality and China could float the exchange rate without fearing that speculation would distort the value. It is in China's best interests to pursue this course, in my view," he said
Under this scenario which he estimates has a 50 pct chance of happening, China's economy will likely experience an orderly slowdown, with a cool down in prices of natural resources and eased inflationary pressures. "When China cools its economy by raising interest rates, it would decrease speculation in the renminbi and help stabilize the US dollar. A stable dollar and lower commodity prices would give the Fed more time to raise interest rates. It could create the best policy combination between China and the US to achieve a global soft landing," Xie said. In a second scenario which he estimates has a 25 pct probability, China may opt to keep the status quo, just like what it did in 2004
Under this setting, China's economy will unfold depending on the extent to which excess capacity affects profitability of companies and how fast the US Federal Reserve raises interest rates. "If US inflation surprises on the upside, the Fed would raise interest rates faster than expected. The higher and faster rising US interest rate would cause hot money to leave China, which would bring down property prices and slow fixed investment," he said
Xie said another scenario, which he gave only a 10 pct chance, is for China to bow to international political or internal inflationary pressure and revalue the yuan by 15-25 pct
"Such an approach is likely to lead to a hard landing as the massive amount of hot money flows out to realize profits. Commodity prices would fall sharply as a result and the dollar would strengthen," he said
China will immediately suffer deflation as falling commodity prices and excess capacity cause prices to decline. Xie said China could also allow the yuan to appreciate slowly as an alternative policy direction. Under this scenario, appreciating the currency gradually would attract foreign speculators and suck in more hot money that would enable the property industry to unload its excess inventory
"If this scenario does unfold, I believe it would cause another wave of global speculation. Massive speculation would push the dollar down and commodity prices up," he said
China's actions will essentially extend the Fed liquidity bubble by creating more demand for liquidity under the same Fed Funds rate. Foreign demand for Chinese properties will likely rise, he noted
However, this situation would cause property construction to increase even more with another wave of hot money. Six months later, China would face more investment excess and a hard landing might be inevitable
"Since this scenario only helps the property industry to unload its inventory and no one else, I think it is unlikely to materialize. However, the property industry has become the most powerful lobbying group in China, so I would not dismiss this scenario completely. I assign a 15 pct probability," he said |
