Asia gains as Wall Street slide halts, kiwi tumbles

TOKYO (Reuters) - Asian stocks rose on Thursday, encouraged by gains on Wall Street, while the New Zealand dollar tumbled to a five-year low after the central bank cut interest rates for the first time in four years as the economy slows.... more

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S Korea cuts interest rates

South Korea"s central bank cut interest rates to a record low, a move seen as an attempt to stem the economic fall out from an outbreak of the Middle East Respiratory Syndrome (MERS).... more

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Craig Stephen"s This Week in China: China"s central bank feels the heat from falling Japanese yen

HONG KONG (MarketWatch) — If the job of China’s central-bank chief was just to keep a stock-market bull run going, he should be getting top marks, as last week the Shanghai Composite Index SHCOMP, +0.90%  burst through the 5,000-point level for the first time since 2008.

But People’s Bank of China (PBOC) Gov. Zhou Xiaochuan also has to worry about managing scary debt levels and falling prices, even if he can ignore the growing disconnect between the economy and equities. This might explain why Zhou has recently repeated warnings about rising deflation threats.

Likewise, big moves in the currency markets — where last week, the dollarUSDJPY, -0.12%  hit a 13-year-high against the yen at ¥125.72 — should be getting his attention.

This forex action promises to make China’s problem of falling prices yet more uncomfortable, as the Chinese yuan’s USDCNY, +0.1145% USDCNH, -0.0306% trade-weighted exchange rate appreciates due to the currency’s loose peg to the dollar. Last Friday’s strong U.S. jobs report will further turn up the heat, as it brings closer the arrival of the Federal Reserve’s first rate-hike and potentially more dollar strength.

Now, some analysts are warning that the yen is ready to fall even further and ignite a fresh round of currency wars. According to strategist Albert Edwards at Société Générale, the yen has broken through key 30-year technical support, and its next stop could be a further slide that sends the dollar up to ¥145.

Such a move would almost certainly trigger another round of competitive devaluations as the yen acts as an anchor to many of the region’s currencies. Various economies in Asia are already suffering from deflation and falling exports. Both Thailand and Taiwan have now recorded a fifth consecutive month of falling consumer prices, while South Korea’s retail prices are only just staying positive with a 0.5% gain.

Deflation is a particular worry for China as its risks plunging the economy into a debt trap, with the size of its real debt obligations growing. The other reason deflation is the No. 1 enemy of central bankers is that it can undermine growth by triggering a vicious cycle where purchases are postponed and general economic activity slows.

Evidence of deflation appears to be growing despite China’s consumer price index hovering at 1.5% inflation. Producer prices having been in decline for 38 months, and China’s GDP deflator has moved into negative territory, falling 1.2% year-on-year in the first quarter.

According to SocGen’s Edwards, the experience of Japan tells us that this indicator is a more accurate measure of what is really going on with prices, rather than the CPI, since the deflator typically covers a far wider basket of goods and services.

Although Zhou has now cut Chinese interest rates three times, as well as slashing banks’ reserve ratio by a full percentage point in April, the problem is that these actions look feeble when other central banks are both cutting rates and letting their currencies slide. Analysts argue that any PBOC stimulus has been neutralized by the combination of yuan appreciation and capital outflows.

The consensus remains that Beijing will suck it up and try to ride out the pain of a higher trade-weighted exchange, resisting entry into the currency wars.

This is based on a belief that Beijing is determined for the yuan to be included in the International Monetary Fund’s Special Drawing Rights facility later this year, such that it will not permit a devaluation to jeopardize this goal. Inclusion helps give the yuan acceptance as one of the world’s major currencies and will also support its use in various state-led infrastructure-investment schemes which Beijing has recently announced.

In the meantime, expect a policy response to try to alleviate the pain caused by the yuan’s strength.

This could include more tax reform to encourage domestic spending over spending abroad. There have already been cuts to import duties on sneakers, diapers and face creams, and there is speculation this may be extended with major reform of the value-added tax.

Such a move is likely to be negative for Hong Kong retailers which focus on tax arbitrage, although it’s questionable how effective it will be in curbing regional trade, given the sharp falls in currencies like the yen.

Another Chinese response is to try to dump excess capacity onto world markets. There are already signs of this occurring with steel, where Chinese exports increased by almost 100 million tons last year. This is now running into political opposition as India, Malaysia and South Korea have recently announced anti-dumping tariffs on some Chinese steel products.

The most difficult policy choice for Zhou appears to be how to apply further monetary stimulus in the face of falling prices and slowing growth. This is where China’s domestic policies interact with global currency markets.

More rate cuts could further stoke the bull market for stocks, but the risks are rising. If they happen as the U.S. Fed finally tightens, they could also be the trigger for damaging capital flight.

By

CRAIG STEPHEN

 

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The Chinese Central Bank Is Nearly Done Freeing Up Rates. Now Comes the Hard Part

(Bloomberg) People’s Bank of China Governor Zhou Xiaochuan has been pursuing a market-based interest-rate system for over a decade. He’s almost done. Now comes the hard part.

From overnight interbank borrowing to long-term bank lending rates, there are no longer restrictions on the price of money in China. The remaining regulatory sanction that banks can’t offer savers rates more than 150 percent of benchmark deposit levels will be lifted by the end of 2015, according to the timetable made public by Zhou himself.

So the rules are now largely in place for credit to flow through the economy based on potential returns. That’s a sharp contrast to the days when Zhou took over the central bank in 2002 when Alan Greenspan was Federal Reserve Chairman and the price and flow of money in China was largely decided by the PBOC. The task now is to translate the new rules to reality.

“Zhou’s interest-rate liberalization push is approaching its end,” said Yao Wei, a China economist at Societe Generale SA based in Paris. “But it’s the beginning of the end, it’s not the end itself.”

Bloated, corruption ridden and debt burdened state-owned enterprises need implicit government guarantees revoked, so banks no longer view them as safer bets than riskier, more nimble private enterprises. Consumers need to be coaxed to borrow and spend more, to fill the gap as investment wanes.

Progress on those fronts is slower.

State Enterprises

“A key element in interest rate liberalization is that market players have to be sensitive to prices,” said Gu Ying, vice president of Asia local market research with JPMorgan Chase & Co. in Hong Kong, who previously worked for the PBOC. “However, state enterprises and local governments are still not very sensitive to prices, and that’s a problem the central bank alone can’t solve.”

Then there’s the capital account — the flow of money across China’s borders. For a truly liberalized interest rate setting, companies and individuals need to be able to move cash more easily, with all the economic volatility that entails.

“A freer interest-rate system can help foster a market-based financial system at home, and this in turn can help capital account opening,” said Zhang Bin, an economist with the Chinese Academy of Social Sciences. “But is China really ready for full capital account opening? The answer will be ’no’ partly because the exchange rate system is not liberalized.”

Zhou has stepped up his push this year. He started a deposit insurance program to protects savers; he’s twice raised a cap on what lenders can pay savers; and this month came certificates of deposit — instruments that allow banks and savers to meet on interest rates independent of PBOC benchmarks.

Long Tenure

Zhou’s tenure spanned the three government administrations of premiers Zhu Rongji, Wen Jiabao and Li Keqiang, the last of whom assumed office in 2013 during a once-a-decade leadership transition. The acceleration of reforms suggest Zhou has “decided to seize the moment” politically, Andrew Batson, China research director at Beijing-based consulting firm Gavekal Dragonomics, wrote on his blog last week.

For China, freer interest rates promise to make savers wealthier, aiding the economy’s transition to a more services and consumer driven economy. Private enterprises will have better access to capital, meaning the most productive forces get the money they need to expand. And wasteful, uneconomic investment by state-backed firms should become less common.

The challenge is to make those potential gains a reality.

“China’s interest-rate liberalization is almost done, but the financial system liberalization is far from over,” Zhang of CASS said. “There are borrowers taking whatever costs because they don’t have to worry about repayment. There are banks making loans on political considerations. And there are other problems. But the progress can’t be denied.”

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