Plugging the wrong hole

MARKET MANIAC

For those of you who haven't heard, China is fast becoming the new United States, at least to judge from its consumption of commodities.

Last year, it accounted for (consumed) nearly a third of the world's finished steel production, and it has been the single loudest reason for a horrifying/delighting rally in prices of copper, nickel, aluminium, coal and, yes, steel.

As if underscoring its importance, the Baltic freight index, a measure of the cost of shipping bulk cargo globally, has also risen sharply over the past year, making ship owners squeal like schoolgirls and commodity users wince twice over.

That China today is an unparalleled phenomenon is borne out by a recent report by a consultant from Cambridge Energy noting that China's electricity consumption grew by 15 per cent last year and 10.4 per cent in 2002 "" a spike in demand that was equal to the total power consumption in Brazil. "They are adding a middle-sized country every two years in terms of energy consumption," he said.

Of course, this has been going on for some time now and there are signs that China's boom may be getting ready for a correction. Press reports indicate that money supply is getting out of hand, and there could be a speculative bubble forming in various assets. There is even some talk that the Chinese government is seriously considering making the renminbi's exchange rate more 'flexible' to rein in inflation.

However, irrespective of how the immediate future plays out, it is clear that China is already a key determinant of world growth and Chinese growth is "" and will increasingly be "" a major force in business decisions the world over.

Thus, just as strategic decision-makers pore over US economic statistics to develop a 'feel' of what the economic environment will be like in the near and not-so-near future, they "" we "" will soon need to (indeed, already need to) pore over detailed Chinese economic statistics to make many key business decisions.

For instance, if US growth continues strong over the next few quarters, Indian IT companies can continue to increase hiring. If it is expected to slip, the BPO business could accelerate, as economics will always trump politics in even the near term.

So, too, if Chinese growth is going to continue like gangbusters, steel companies and shippers should run to the capital markets to raise money while the going is good. If it is expected to surge for one or two more quarters, then dip for a year or two, perhaps the planning should be a bit more circumspect.

The problem, of course, is that there is very little hard information available about the Chinese economy. And what's available may not be particularly credible. The Chinese have always been considered inscrutable and this characteristic appears to have carried over into its new global incarnation.

Information collation in China remains modest "" might I say, third world "" to say the least. I mean, when did anyone see 'official' first quarter GDP figures, or monthly non-farm payrolls or consumer confidence data coming out of China?

Thus, as China increases in global economic importance, more and more strategic business decisions are going to have to be made with much less information than would have been thought necessary.

Which means that the risk on these decisions is going to be higher.

Which means that the risk on other decisions is going to have to be lower, until global risk appetites increase appreciably. (The series of bomb blasts in Spain last week, riding on top of the already low global tolerance for risk, suggests that this is extremely unlikely, at least in the reasonably visible future.)

Which means that US interest rates will continue to be lower than expected by hard economic numbers, since one way to reduce the average risk of the pool of global savings is to invest a larger chunk of it in 'risk-free' US government bonds. (This may account, to some degree, for the doggedness with which Asian central banks have been 'supporting the dollar'.)

Which means that arbitrage-seeking dollar flows into India (and other emerging markets) will continue unabated, and will probably increase as we go forward. (I would point out, incidentally, that RBI has bought an average of over $ 1 billion a week over the past 16 weeks, as part of its exchange rate management.)

Which means that RBI's finger-in-the-dike approach to management of capital flows will be shown up for what it is sooner rather than later. (I would point out, incidentally again, that RBI has recently announced that it plans to arrange for the Government to issue Rs 60,000 crore of Market Stabilisation Bonds, so it can continue with its 'buy dollars and sterilise the intervention' approach. I would further point out that Rs 60,000 crore is around $ 13 billion; at a billion a week, this works out to a further 13 weeks "" a short-sighted approach, if there was one. Or, maybe, a sign of desperation.)

Which means that the rupee will begin to strengthen again soon. (Unless, of course, RBI plugs the other hole by buying forwards to close the arbitrage window.)

jamal@mecklai.com