SMART MONEY

La Presse Business (Tunisia) - - SOMMAIRE - By Hen­ny SENDER

THE END OF DEFLATION IN CHINA WILL BE FELT AROUND THE WORLD

At the end of last year, a group of investors de­ci­ded to take the Nas­daq-lis­ted, China-ba­sed com­pa­ny Qi­hoo 360 pri­vate. Their big­gest concern whe­ther they could get a high en­ough price. They did - $9.3bn in­clu­ding the as­sump­tion of $1.6bn in debt. But the au­tho­ri­ties’ sharp watch against ca­pi­tal out­flows meant the pro­cess took far lon­ger than ori­gi­nal­ly ex­pec­ted. That is be­cause ac­cor­ding to Chi­nese law these investors, led by Se­quoia Ca­pi­tal China, had to create a do­mes­tic com­pa­ny on the main­land to buy the Qi­hoo shares from fo­rei­gn investors. The sub­sequent money trans­fer to those off­shore hol­ders re­qui­red ap­pro­val from Bei­jing, which took far lon­ger than ex­pec­ted. It is just over a year since the ren­min­bi’s 1.9 per cent de­pre­cia­tion and an ad­di­tio­nal 4.3 per cent drop in va­lue against the dol­lar la­ter. To­day the de­li­cate ba­lan­cing act bet­ween al­lo­wing the cur­ren­cy to drop slow­ly, yet avoi­ding gi­ving rise to vast ca­pi­tal out­flows, conti­nues. Ju­ly saw an ac­ce­le­ra­tion in net ca­pi­tal out­flows yet again, though not near­ly as dire as in Ja­nua­ry or a year ago. Meanw­hile, beyond the in­ter­ven­tion of the au­tho­ri­ties to tem­per the flows, the fun­da­men­tals that part­ly de­ter­mine the va­lue of the Chi­nese cur­ren­cy are shif­ting. Most no­ta­bly, China is on the verge of chan­ging from an eco­no­my where prices keep drop­ping to one where deflation is ex­pec­ted to dwindle al­most to no­thing . That is a dra­ma­tic de­par­ture from the past 50 months, when deflation drag­ged down not on­ly prices in China but in most of the world, thanks to ex­ports of chea­per ma­nu­fac­tu­red goods, and fal­ling com­mo­di­ty prices. The end of deflation “is the most po­si­tive de­ve­lop­ment for China”, says Hai­bin Zhu, chief China eco­no­mist at JPMor­gan. The conse­quences will be felt both in China and around the world. The deflation was es­pe­cial­ly se­vere in pro­du­cer prices - a re­flec­tion of the per­pe­tual over­sup­ply in ma­ny sec­tors of the eco­no­my, es­pe­cial­ly those do­mi­na­ted by the state-ow­ned en­ter­prises. Thus in the most recent month, pro­du­cer prices fell 1.7 per cent year on year com­pa­red to 2.6 per cent in June. But on a month­ly ba­sis, they ac­tual­ly rose 0.2 per cent, led by me­tals prices, thanks to conti­nuing in­fra­struc­ture and pro­per­ty in­vest­ment. By the end of Ju­ly, the coun­try was al­rea­dy on its way to mee­ting its steel and coal re­duc­tion tar­gets, ac­cor­ding to re­search from ANZ. Slo­wer in­dus­trial pro­duc­tion and less in­vest­ment is exact­ly what the main­land re­quires. If ana­lysts’ ex­pec­ta­tions that deflation is co­ming to an end are right, the real bur­den of debt will be­come ligh­ter, pro­vi­ding some re­lief to over-in­deb­ted cor­po­rates, and re­mo­ving the big­gest cloud over the coun­try - the concern that the growth of debt is un­sus­tai­nable and a fi­nan­cial cri­sis is in­evi­table. It al­so takes pres­sure off the People’s Bank of China to cut in­te­rest rates and bank re­serve ra­tios when ma­ny fear mo­ne­ta­ry po­li­cy is too tight, yet the cen­tral bank fears lo­we­ring rates lest it spark more out­flows. “The real bor­ro­wing cost is being si­gni­fi­cant­ly re­du­ced for Chi­nese cor­po­rates,” adds Mr Zhu. “It was 7 per cent to 8 per cent last year but could fall to be­low 2 per cent in real terms.” Mo­reo­ver, after a trend for a lack of pro­fits last year, Mr Zhu ex­pects a far brigh­ter pro­fit pic­ture for 2016. Other forces are al­so hel­ping Chi­nese cor­po­rates deal with their debts. Even if the cen­tral bank does not lo­wer rates, the banks are un­der com­pe­ti­tive pres­sure from a do­mes­tic bond mar­ket that poses an at­trac­tive al­ter­na­tive to loans. “Chi­nese bonds have out­per­for­med US bonds in dol­lar terms since 2014, and China is the on­ly coun­try in the SDR bas­ket whose bonds pay po­si­tive no­mi­nal and real yields,” notes Jan Dehn at Ash­more Group in Lon­don. In­fla­tion is al­ways a double-ed­ged sword. If it rises too shar­ply, investors could de­mand hi­gher yields on se­cu­ri­ties to com­pen­sate, and the ren­min­bi could drop, pre­ci­pi­ta­ting ano­ther more vi­cious round of ca­pi­tal out­flows. But Ja­pan, mi­red in deflation, shows the per­ils of that state of af­fairs. At present, Chi­nese hou­se­holds, un­like in Ja­pan, can most­ly earn po­si­tive yields in the go­vern­ment bond mar­ket. This is not the ar­ti­fi­cial­ly high growth of 2009. And China is pro­ba­bly years from being aha­ven. But at least it no lon­ger ap­pears an im­mi­nent sin­khole ei­ther.

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