More overseas investment can curb China’s inflation

11/24/2010 Source: People’s Daily

The excessive liquidity as a result of the domestic and international loose monetary environment is building up a challenging situation for China’s macro-control efforts for its economy. On Monday, People’s Daily called for relaxed control on China’s current account to encourage more outbound investment by Chinese enterprises to curb the speculative attacks on China’s agricultural prices.

On one hand, there is apparently too much liquidity on the market thanks to China’s two-year moderately easy monetary policy and proactive fiscal policy. On the other hand, China’s market is increasingly appealing to foreign capital given the expectation that China’s currency will appreciate and the United States’ recent quantitative easing action.

Hot money is flooding into China. The Ministry of Commerce of China has found that the actual use of foreign investment over the first 10 months of the year soared by 48 percent, much higher than the general growth of foreign direct investment in China in the same period.

The role of the hot money in agricultural products is even more worrisome. This year has seen speculative capital attacking garlic, ginger and cotton on the Chinese market, pushing the prices of those products sky high.

Food and housing accounted for 90 percent of China’s staggering consumer price index, the indicator for inflation, which rose to a 25-month high of 4.4 percent in October. Concerns about China’s ability to control inflation and uncertainty over monetary policy prevailed in the market.

There are suggestions for more stringent monitoring and control on international capital inflow. However, that is very difficult and not enough, said People’s Daily. China has become the second largest trading nation and the first exporter of goods in the world, with its foreign trade in goods accounting for one-tenth of the world’s total. That extremely close connection with the world market makes it easy for hot money to find access into China — through trading credit and foreign direct investment for example — but difficult to be identified and prevented.

Fewer restrictions on foreign exchange under the current account should be adopted, according to People’s Daily. That can encourage more private Chinese companies to tap the international market. The more capital outflow as a result can hedge against the hot money inflow.

In addition, a more flexible, market-oriented yuan exchange rate should be established by improving the yuan exchange rate formation mechanism.

Those measures targeting hot money from outside should, according to People’s Daily, be complemented by more effective control of domestic liquidity through a mix of policy tools like bank deposit reserve and credit control.

China has recently raised commercial bank’s deposit reserve to 18 percent, the highest in the world.

The paper also highlighted the importance of watching closely the investment activities of foreign companies in China. Most of those foreign companies are operating with a view for long-term development in China. However, more supervision should be taken on any speculation.

Leave a Reply