China and Inflation

The central bank of China has raised RMB reserve requirement ratio (RRR) by 50bps third time in last 5 weeks time and 6^th times in 2010 without touching its key 1 year lending rates. The goal of course is to try to slow lending and quell inflation. This has become a huge test and challenge for the Chinese government and even bigger if we consider the Nov CPI figure which is posted at a sizzling 5.1%. On Saturday China has reported that their Nov 2010 inflation (CPI) figures reached on 28 months high (y/y). This might be a possibility that this is a number that Chinese govt. is accepting and the real number most likely is much higher than exposed. If the Chinese fail to act aggressively we could see a sharp spiral in inflation.

It is not clear that the Chinese have the political will or the financial necessity to stop this inflationary tsunami. It seems like they are not very sure about their growth and this fear is resulting in the failure to allow their currency to float which is causing economical imbalances. Another reason can be considered is under developed financial instrument in the market which is making Chinese govt’s way difficult to react on inflationary problems. Over the years, the central bank has bought most foreign currencies flowing into the country to keep China's currency yuan stable and thus injected a huge amount of yuan cash into the system, which needs to be sterilized. Heavy foreign exchange flows in recent years have left commercial banks holding too much yuan, forcing the PBOC to use bill sales and bank reserve requirement ratios to sterilize it, Wu was quoted as saying. It sounds bad but seems to be true that “if China doesn’t stop inflation then inflation may stop china.”

Weekly FX update

USD rose against most of the global currency pairs on Thursday 09/12/10. The day was significantly good which initiated volatile trading. As a result the USD not only strengthen against EURO but was looking in sound position against GBP, since the economic figures in Britain left must be desired. The increase in the demands of US Treasury bond (hence lower yields) resulted in terms of decline against JPY. Apart from all this one more news came in market that Ireland’s opposition Labour Party decided to vote against the bailout of IMF and European Union and downgraded ratings of FITCH for Ireland turned into a positive factor for strong performance of USD.

The last trading session of the week was mixed for EUR, so was the market’s reaction to the market data. The disappointing factor for EUR was the poor demand at an auction of 2 year bonds on Wednesday (the third German bond sale in a row was undersubscribed). The good news was from US Treasury yields which helped EUR to cover most of its losses. The GBP was selling off against USD by the end of last trading session of the week. According to a report house prices in Britain went down (Y/Y basis) first time in last 12 months. The trade balance deficit grew to 8.5bn against 8.4bn (September) and 8.1bn (expected). According to a forecast, growth is slowing down, though the price is still creeping up, which may give the BoE new reasons for the toughening – and it can in no way be considered a positive factor for the British economy.

The pair USD/JPY declined on Thursday’s session and a mixed response on next session. US yields came off a little, which is a dollar negative, plus Japanese exports grew. Strong demand for the US 30-year bonds reduced yields a bit, triggering the dollar’s fall and, as a result, the yen’s strengthening. If there are no surprises in debt markets, in regards of US Govt. Bonds, this pair should perform consistently. Some rumours are circulating that China could raise interest rate which most likely will be a kind of support for USD despite of positive unemployment claims data.

Equity markets in India tumbled badly and underperformed all Asian peers and ended lower around 2.3% which was one of the reasons behind low performance of INR which closed low 0.3%. Some major economic events can be noted down as:

1. The total borrowing from Banks under RBI’ LAF was accelerated (124,780 Cr. On 9^th Dec, 2010)
2. Bond prices continue to consolidate. Yield on 10 yr benchmark Govt. bond almost ended flat.
3. INR ended lower against all major currency pairs.
4. FII’s outflow continues to accelerate (on week ended Dec. 9 the net sell was approx USD 287.63mn in equities while net buy was approx USD 3.4mn debt instruments.

Comments are most welcome.