China Update

There are several noteworthy developments from China.

The first, while still a bit sketchy, seems the most promising. President Hu seemed to signal an acceleration of infrastructure construction in the western part of the country. The top economic planning agency indicated earlier today that China will invest CNY682 bln (~$100 bln) in 23 new major infrastructure projects beginning this year. This effort follows the CNY2.2 trillion investment in 120 infrastructure projects in the 2000-09 period. The announcement seems to have coincided with the rekindling of the risk appetite and the lifting of the commodity currencies. Separately, but related, reports suggest China will cut the corporate tax for western regions to 15% from 25%.

Second, the Nikkei reported that China dramatically expanded its JGB holdings in recent months. Last year China appears to have sold a net JPY80 bln of Japanese government bonds. In the first four months of this year, China appears to have bought JPY541 bln of JGBS, of which JPY200 bln appears to have been purchased in the month of April alone. The PBOC was quick to respond that this was not a sign of it divesting euros. There are some JPY621 trillion outstanding JGBs, so China's holdings are quite modest. Foreign investors hold around 3% of the outstanding JGBs. Moreover, Japanese government figures suggests that 96% of China's purchases of for instruments with maturities less than a year. China had bought a great deal of US Tbills during the heart of the financial crisis. As they matured, China rolled about 2/3 into Treasury bonds.

Third, there are news reports suggesting that China's sovereign wealth fund may reduce its holdings of Chinese banks to overcome objections by US officials that may be slowing its ability to expand more in the US. This story might not have immediate market impact but it could portend for stakes in US companies by China's sovereign wealth fund.

Fourth, the initial public offering from China's Agricultural Bank is set to be completed tomorrow. This has distorted the money markets as funds locked up during the subscription period forced rate higher. The completion of the IPO could free up funds and ease rates. The Agricultural Bank seeks to raise about $20 bln and reports suggest that interested may be above $70 bln. Those who fail to secure their full allocation will receive funds back on 9 July and this may see money market rates, like the key 7-day report rate eased form the nearly 2.7% reached today. It may find an new equilibrium rate of 2.30% to 2.5%.

Since China announced the tweaking of its currency regime, the yuan has shown better two way price action within a slightly rising trend. In the 12-days of the new regime, China has allowed the yuan to weaken two consecutive days in both the first and second weeks. The yuan weakened on yesterday and today. The pattern would suggest the yuan will rise tomorrow.