Greece Kills (Atleast Delays) Yuan Revaluation


Last week I gave you my reasoning for why the Greek crisis was killing any revaluation of the Gulf States currencies against the US Dollar.

Today, I want to speak to you about another victim of the Greek tragedy - The Chinese Yuan.

China's GDP growth surged in 1Q, but the chances of further policy tightening are fading as a result of events in Europe and a still unfolding correction in the property market. I now expect no rate hikes in 2010, while the resumption of currency appreciation is delayed until end-3Q.

My GDP forecasts for 2010 and 2011 are unchanged at 10.5% and 9.0%, but the forecast assumes a gradual softening in the data in the 2nd half of the year. Worries about China will harden especially as the global crisis continues to pick off once apparently solid pillars of global growth.

Sequence of Events that may unfold:

In the beginning, industrial production will begin to slow. The three-month ago change is already slowing. Industrial production growth could slow to 15%y/y in 2nd half, versus a stunning 19%y/y in late 2009. Electricity production is also beginning to slow.

Second, fixed investment is similarly slowing owing largely to a slowdown on public investment projects. Also, recent tightening measures aimed at the property sector are also expected to slow down spending.

Next, credit growth continues to remains strong. But there are concerns about the banking sector's ability to finance an annual credit target of 7.5 trillion yuan, especially if higher capital ratios were imposed. A few months of unexpectedly low credit growth would shake market sentiment.

Finally, the PMI is struggling to rise from already elevated levels suggesting activity has peaked. While the sub-indices are holding steady for now, but ut remains to be seen as to how long this will hold.

Inflation may tend to surprise us on the up side. Food prices appear to be stabilizing, with vegetable prices even falling. Importantly, there is no sign of a food price spike that would challenge the forecast.

With growth stabilizing, or slowing, and CPI unlikely to move much above 3.5%, I expect no rate hikes in 2010. (My earlier forecast looked for two hikes in June and September).

I would still like to see a rate hike. Regulatory tightening is effective. But if China plans to move towards a more market-based economy, especially a market-based allocation of credit, then interest rates will play an important role.

Europe's troubles and the collapse in EUR/USD will delay any change. Yet, current conditions equally offer an opportunity to adjust FX policy without rewarding speculators, while foreign criticism of a cheap CNY will only grow.

I now expect CNY appreciation to resume only by the 3rd quarter.

So the Greeks have claimed one more victim in the currency markets as an unintended consiquence of their unfettered spending.

Ashish Advani 

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