Thursday, 21 February 2008

China can privatise to sterilise

The news that Chinese inflation reached an annual rate of 7.1% in January provides some support for critics of China’s exchange rate policy like Ken Rogoff who warn that selling renminbi to hold down its value against the US dollar is expanding the money supply and fuelling inflation. Although the People’s Bank of China (PBoC) sells sterilisation bills to absorb the base money (ie banknotes plus commercial banks’ settlement balances at the central bank) created by its currency intervention, the market for these central bank bills could be reaching saturation point. It may have become impossible to sell enough bills to fully sterilise ongoing intervention without driving short-term interest rates up to a level which makes the renminbi more attractive and hence the task of preventing its appreciation even harder. This could explain why, as reported on Bloomberg, the inflation report was accompanied by a PBoC statement that it will “increase innovation in monetary policy measures”.

As readers of the comments on Brad Setser’s blog may recall, RebelEconomist suggests an alternative sterilisation tool: the Chinese authorities could sell some stakes in state-owned enterprises (SOEs) instead of sterilisation bills.

Privatising SOEs would be consistent with other Chinese economic policies. The authorities would like to brake economic growth, and the Chinese stock market has probably been a more important source of economic stimulus than low interest rates. Increasing the supply of stock could be expected to lower stock prices and raise yields. While the stock market has fallen back since last year, it does arguably remain over-valued and the authorities would probably be content to see a controlled decline continue. It is known that the Chinese government wants to list most large SOEs, which presumably means floating a significant proportion, if not the majority, of their shares. Privatisation is supposed to increase economic efficiency, and may improve corporate governance.

In fact, because Chinese stocks are so expensive, given present yields on stocks and central bank bills, selling state shareholdings instead of bills would lower the current cost of sterilisation.

The state has no shortage of shareholdings to sell. The State-owned Assets Supervision and Administration Commission (SASAC) is responsible for several hundred SOEs which made a combined profit of about $100bn in 2006, which would suggest that their current collective market value is of the order of several trillion dollars. The state holding of PetroChina alone is worth over $500bn; more than enough to completely sterilise another year’s reserves accumulation at the recent pace.

Since base money is of indefinite duration, equities are arguably a more appropriate sterilisation instrument anyway than bills, which need to be rolled over until the economy grows sufficiently to hold the excess stock of base money created by intervention without inflation.

Apart from vexing existing holders of Chinese stock (which may be inevitable anyway if the authorities want to restrain the boom), the main obstacle seems to be coordinating the various state institutions involved, from the central bank to layered holding companies, but this should not be insurmountable, given the political will.

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