Saturday, November 08, 2003

More on China and Commodities

The inflation in commodity prices caused by China growth continues. Remember we in the OECD are also dependent on the terms of trade:

Xinhua state information agency reported that China has maintained a "basic balance" between supply and demand for major agricultural products since the late 1990s. Yet, national grain production is down for the fifth consecutive year, say experts. Inflation and decreasing grain reserves are worrisome.

The explosive demand for commodities in China has caused prices to rocket also at global level. Imports of grains and oil-seeds have doubled compared with last year. National grain production is down again for the fifth year consecutively. This year in particular, yields of all three major crops; wheat, rice and corn have dropped. Total national grain output is expected to fall below 450 million tons. If the trend does not change, it could result in a shortage by 2005, said the China daily on Thursday.

Inflationary trends have been recorded for grain, cooking oil, meat, eggs and fodder. The price hikes, which began in Beijing, Nanjing and Zhengzhou, quickly spread throughout the country. Purchase prices for wheat went up by 40 to 80 Yuan (US$ 4.80 - 9.70) per ton in major wheat production areas such as Henan Province. Prices for corn rose by 80 Yuan in northern China, while prices for rapeseed and rice increased by 20 and 10 per cent, respectively, in Anhui Province.

Farmers, who have been suffering sluggish income growth over the years, welcome higher prices. Still, that has its implications on the national agricultural market. The growing demand for grain stimulates imports from abroad that has other implications on the nation's trade balance.

Experts are expecting grain shortages. "China has been using its grain reserves to balance the market for the last four years," said Wan Baorui, vice-chairman of the Agriculture and Rural Affairs Committee of the National People's Congress. "The reserves can be used for, at most, another two years."

Since 2000, annual national grain demand has stood at 480-490 million tons, 25-35 million tons more than the annual output. Fundamental changes have caused that the national grain reserve have diminished. Not only natural disasters but also shrinking acreage slowed down the long years of oversupply. Moreover, rapid urbanization has been eating up grain fields.

In addition to the swift expansion of towns and cities, many regional governments have reserved large parcels of land for "economic development zones" meant to attract foreign investment, but many such zones simply lie empty due to a lack of infrastructure or adequate local investment, said the China Daily.

The low grain prices in the past have led to farmers' declining enthusiasm for planting it. Heavily burdened by various taxes and charges, most farmers would rather grow more profitable crops, such as peanuts and cotton, or migrate to the cities to look for better earnings. The latest government statistics indicate that 80.7 million rural labourers were working in cities at the end of September.

Professor Li noted that total global output of the three major crops this year would come to 2.03 billion tons, down 63.3 million tons from last year, marking the sixth consecutive year that the figure has dropped. The world grain market, meanwhile, experienced its biggest price fluctuations in seven years, said the China Daily.

Due to population growth, increasing consumerism and economic growth the grain demand is rising. Although, China must make every effort to guarantee that at least 90 per cent of demand is met by domestic supply, as grain is a product involving national security, that target is not reached so far.

To realize this target, Han Jun, an agriculture researcher with the State Council Development and Research Centre said, national grain acreage must be kept stable, at around 1.07 billion hectares. Han also suggested the central government abolish agricultural taxes in five years while taking strict measures to curb the occupation of farmland for industrial development and other purposes.
Source: China Biz

This Was Not So Unexpected

Not for me at least. Germany is struggling, there is no easy and rapid cure. Equally one month thigs go up, and the next they come down. Or this month they go down and next month they go up. What you shouldn't expect is a clear and pronounced upward march.

German industrial production unexpectedly fell for a second month in September, held back by the effect of summer holidays, a government report showed, a sign the way out of recession for Europe's largest economy may not be smooth. Production at factories, construction sites, utilities and mines dropped 1.2 percent after declining 3.7 percent in August, the Economics and Labor Ministry in Berlin said in a faxed statement. The median forecast of 31 economists surveyed by Bloomberg News was for a monthly gain of 2 percent.

"There's a lot of talk about hope that we have bottomed out,'' said Robert Koehler, chief executive officer of SGL Carbon AG, the world's largest maker of carbon and graphite products. ``I'm not sure if we'll really see top-line growth worldwide.'' At least six reports in the past four weeks, from rising factory orders to falling unemployment, indicated the economy is reviving amid an acceleration in U.S. growth. Still, companies' third-quarter earnings reports have been mixed. SGL Carbon will cut more jobs in coming years and may shed one of its four units after forecasting a loss for this year and little- changed sales in 2004. Bayerische Motoren-Werke AG, the No. 2 luxury car maker, raised profit for the first time this year last quarter. The Economics and Labor Ministry, which said the summer holidays curbed production in September, said it expects industrial output figures for that month to be revised ``markedly'' higher.

Bundesbank President Ernst Welteke estimates Germany's $2.3 trillion economy grew 0.2 percent last quarter. The third-quarter gross domestic product reports is scheduled to be released by the Federal Statistics Office in Wiesbaden on Nov. 13. The euro, which has appreciated more than 13 percent against the U.S. dollar in the past year, may have hurt production. The single currency rose to a record of $1.1933 in late May. It traded at $1.1427 at 11:51 p.m. in Frankfurt. "When the euro rises, we lose sales,'' said Rudolf Winning, chief financial officer of Zapf Creation AG, Europe's largest maker of dolls. ``A rate of $1.10 to $1.15 reflects the fundamentals of the economy.'' The company last week cut in half its estimate for full-year operating profit partly on the euro. In a two-month comparison, which smoothes out short-term swings, German industrial production fell 2.9 percent in the eight weeks through September from the previous two-month period, the ministry said.
Source: Bloomberg

Trichet Backs the Pact

Jean Claude Trichet the new governor of the ECB is trying to convince the media that 'things have changed'. Hopefully he is right. In order to try and set the stage for his term of office, he is quite forethright about his views on the Stability Pact. (Anyone who doesn't visit Fistful regularly could try this post and this one).

Jean Claude Trichet, the European Central Bank's new president, on Thursday warned eurozone countries that the rules underpinning the single currency were "now at a critical point". In a polished performance at his first press conference since taking over from Wim Duisenberg, Mr Trichet said the stability and growth pact provided "an appropriate framework" for ensuring fiscal discipline. He said the budget deficit limit of 3 per cent was "the anchor" for the pact. "It must not be placed in doubt," he said. His remarks came as the ECB held its primary interest rate steady at 2 per cent and signalled rates would remain on hold for some months amid signs that the eurozone economy was finally beginning to pick up speed.

The Bank of England on Thursday raised UK interest rates for the first time in almost four years, making it the first of the world's four leading central banks to tighten its policy since 2000. But Mr Trichet gave no indication that the ECB was close to following suit. The central bank was now more confident about the upturn in the eurozone economy, he said, and "anticipated some stickiness" in inflation rates over coming months because of higher food and oil prices and increases in indirect taxes. But he insisted that price pressures would eventually moderate. Economists said the bank appeared to have adopted neutral "wait-and-see" stance on monetary policy. "A reduction is possible . . . but looks increasingly remote," said Lorenzo Codogno of Bank of America. Mr Trichet also stopped short of giving any signal the ECB was looking to tighten monetary policy in the near term.
Source: Financial Times

Trichet: A Man For All Seasons?

Yesterday was a reasonably interesting day over at the MS Gloabl Forum. Eric Chaney welcomes the arrival of Jean-Claude Trichet, and in so doing makes an interesting point. The demographic changes may make for a more deflationary atmosphere. When I started saying this publicly over a year ago I felt myself to be a very lonely voice indeed. Every day now I notice more and more people who are thinking about the argument. This can only be to the good. On another angle, I do hope he's right, and that Trichet is 'pragmatic'. What a breath of fresh air that would be!

All that is good, I am often told, but since Trichet got his medals as an inflexible inflation fighter and a true believer of the virtues of a strong currency, will he be able to cope with the challenges of a deflationist world? Although nobody knows if deflation will be a permanent feature of the next eight years, the risk is still there, as the abnormally low level of inflation in the US eloquently reminds us. As far as Europe is concerned, secular demographic trends may increase the risk of deflation: After all, inflation or deflation reflect social preferences, to some extent, and the growing number of pensioners in Europe might tilt the social balance in favor of deflation. This is why a central banker must be open minded and pragmatic. I think that Jean-Claude Trichet has proved he has these qualities in two particular circumstances. First, instead of abandoning ERM rules after the 1992 crisis, he convinced his partners to make the system flexible enough to cope with future speculative tensions, by adopting a large fluctuation band. This proved successful in 1995. Second, in 1998, when financial markets thought that euro interest rates would be some kind of weighted average of member countries’ past rates, Trichet, well aware of the dangerously low level of inflation in core countries (starting with France and Germany) and convinced that averaging Italian and German rates would dilute the credibility of the euro, argued to set the initial level of interest rates at the lowest possible level (3%), despite strong opposition from some countries. This is the man who did not hesitate to push French rates to 7%, then fought to cut them to 3%; simply, times were different. I would call that pragmatism.
Source: Morgan Stanley GEF

Germany: Whither the Structural Deficit?

Following up on the last post, just how big is big in the case of the German deficit. Morgan Stanley's Elga Bartsch has a stab at making a 'best guess' (BTW the problem with giving Brussels giving short term stimulus now for structural reductions later is that if the problem deteriorates rather than improves with time, there really will be a push-comes-to-shove situation in two or three years time.)

Even though we have to wait for the fresh tax estimates to be released in order to finalise our assessment, our best guesstimate for the general government deficit for this year now stands at 4.2% of GDP. Previously, we had expected the Maastricht deficit to amount to 3.9% of GDP this year. According to government estimates, the federal budget deficit alone likely overshot by more than 100%, forcing the finance minister to submit a supplementary budget for 2003 in order to get a net borrowing requirement of €42.3 bn approved by parliament. So far, Herr Eichel only has a mandate to run a deficit of €18.9 bn this year. Both the supplementary budget for this year and the official government estimate for the Maastricht deficit, which will likely show a 4%-plus reading, are largely water under the bridge though.

What is of more importance, however, is the outlook for next year’s budget deficit. This is because according to the Excessive Deficit Procedure, in principle at least, next year would be the year in which the German general government deficit should be back below 3%. In our view, however, it is highly unlikely that the German government will be able to reduce the deficit that drastically. Instead, we estimate the deficit to be on the order of 3.6% of GDP next year. This constitutes a slightly more optimistic view than the one held recently (see Three Cheers for the Chancellor, 22 July 2003), reflecting a more drastic consolidation of subsidies and other tax breaks as well as serious efforts to contain health care and pension spending. But this might still not be enough to prevent the EU Commission from proposing additional consolidation measures to the German government. As in the French case, it seems that the Commission would be willing to allow Germany to stay above the 3% deficit ceiling for another year in exchange for a reduction in the structural budget deficit of 1% of GDP. At the moment, however, the government has delivered half of that.
Source: Morgnan Stanley GEF

Killing the Stability Pact with Kindness?

There's an interesting tussle going on in Brussels at the moment, involving arguments which essetially involve long-term credibility. Short term this may find a not-too-difficult 'compromise' solution, but long-term I think it is an indication of problems to come:

Germany and France were on Monday accused of trying to "kill" Europe's fiscal rules, as EU finance ministers met amid mounting political tension in the 12-country eurozone.They claim to have found a legal loophole that might allow them to escape the threat of sanctions under the EU's stability and growth pact. But their manoeuvre has enraged the European Commission and some smaller countries, which claim it would destroy the pact's already weakened credibility.

Karl-Heinz Grasser, Austrian finance minister, urged his EU colleagues to stand up to pressure from France and Germany, the eurozone's two most powerful economies.Speaking ahead of Monday night's eurogroup meeting of 12 single currency finance ministers, Mr Grasser said both countries must face the consequences of breaching the pact's deficit rules for three years in a row. "We all are obliged for our own credibility and the credibility of the euro to find a way out," he told Reuters news agency. "The way out cannot be by killing the stability pact and putting one pillar of our monetary union at stake."

The 12 members of the single currency are at the point where they must decide if they are serious about enforcing the pact, designed to enforce fiscal discipline across the eurozone.They must decide this month - either on Tuesday or more likely at their next meeting on November 25 - whether to support the European Commission's recommendation to start proceedings against France for its third breach of the pact in 2004.It is the first time the eurogroup ministers have reached this point. Once passed, Brussels assumes powers to direct Paris on how to correct its deficit, and will require Paris to submit progress reports; ultimately fines can be imposed if it fails to comply.

Germany, which will also breach the pact's 3 per cent deficit rule for a third time in 2004, is about to find itself in the same position as France.But rather than face the humiliation of having to submit to economic direction from Brussels, Germany and France are now trying to draw the stability pact's remaining teeth.The two countries, who believe they have support from Italy, Luxembourg and Portugal, want the Commission to suspend enforcement proceedings and adopt a voluntary approach instead.But the Commission insisted that such a step would be illegal under the EU treaty, and that it would not agree to such a retreat. "The Commission has done its job under the treaty, and now it is up to ministers to take up their responsibilities," said Pedro Solbes, EU monetary affairs commissioner.
Source: Financial Times