China’s Oil Price Freeze

Considering recent shortages in fuel in some places in China, as reported by today’s WSJ and an article by the Jamestown Foundation, many may wonder why China is leaving its oil prices at the same level since the last raise in November 2007?

What follows is an analysis focusing on bank loans and stability concerns. More work needs to be done looking into the elite political decisions, namely the discussions between ministers in charge of different portfolios since that can also affect these decisions, but that will have to wait for later.

China wants to present a good image to the world while it prepares to host the Olympic games. The Olympics are a coming-out ceremony for them, an opportunity for much 爱国 (aiguo) or love of country/patriotism. Red, the color of China, appears everywhere. Even PEPSI changed its traditional blue to red in the run up to the Olympics. As one Chinese said in the article: “I thought it was a good idea when I saw those promotional cans. They’re supporting Team China.”

So, what stereotypes does China have to promote to present a good image of their country?

1.) China is not backward

Thus they have retranslated many formerly amusing signs that made little sense in English, such as “Deformed Man” signs outside toilets for the handicapped.

2.) China is ruled by law and order and every Chinese loves China.

Thus, they will increase security and recently presented new regulations aimed at discouraging protestors, both from outside and inside the country. Additionally, the recent clampdown on foreigners overstaying and sometimes working on tourist visas is somewhat based on this. China wants to catalogue all the people inside the country. Laxity in law enforcement is dissipating as the government becomes concerned that foreign elements might seek to upset the festivities.

This also explains the move to ban liquids on Beijing subways starting on May 9th, which appears to be based on International Flight legislation banning liquids on airplanes, and the ban on liquids in other major cities’ subways around the world.

Additionally, the ban of reporters from travelling freely in T*b*t is another example of China trying to present a good “face” to the world– if no one is seen protesting, then it doesn’t happen.

And of course China’s press has cracked down against “negative stories”, and the Hong Kong-based South China Morning Post and other media outlets routinely provide evidence of the country’s greater crackdowns on the free speech of the press. (“Free media for Games = media free of bad news, one city says.” South China Morning Post. March 20, 2007.); also see an April 30, 2007 report on: “The Olympics countdown – repression of activists overshadows death penalty and media reforms”

3.) China wants its economy to keep growing.

China has not reevaluated its currency extremely fast in order to control inflation since it fears (since 2007 in fact, when it had only appreciated 5% against the dollar since the July 2005 depegging, compared to the over 20% it has appreciated by April 2008) that exporters will not be able to survive if there is a rapid reevaluation. Chinese exports to the world have risen exponentially since the early 2000s as the multifiber agreement and trade protectionist agreements expired.

If exporters start suffering, then bad loans could accumulate back to levels not seen since 2005/6 when worries about China’s 10-45% nonperforming loans in state banks led some people to predict an imminent banking collapse– that did not happen, however (China claimed state banks NPLs were only 9.5%) . China seems to have cleaned up it banking act (surprisingly quickly), making its banks at least as solvent as those in America and Europe wracked by subprime.

Some argue that China’s state banks’ cleaned up their balance sheets. However, it appears that some exposure might be hidden. According to the 2006 NYT article: “China Construction had turned in the best numbers at that point, reducing its share to 3.92 percent of loan assets late in 2004, down from 17 percent in 2002… But the risk adviser began cautioning that bad loans were being hidden at the bank’s branches, erroneously labeled as good loans, even though company records showed that they were impaired. He told bank officials that in Beijing and Tianjin alone, he had uncovered $750 million in bad loans that had been deemed good.”

According to an article in Britain’s Telegraph from December 2006; “Less understood is that a sharp rise in the yuan could be the last straw for China’s banks, sitting on a network of loss-making factories living off marginal exports. Standard & Poor’s said a 25pc rise in the yuan combined with a 2pc rise in interest rates would slash corporate profits by a third.”

All these reasons may explain why China raised the reserve requirement to 17.5%. China’s leaders don’t want to risk a hit to their economy’s growth and want to insulate themselves from runs on banks that might happen if loans start to go bad.

As one professor said in regards to a 2006 report on China’s banks, quoted in the NYT: “If there is a slowdown, there will be a day of reckoning. It might be in a long, long time or it might be the day after the Olympics.”

BUT WHY WOULD RAISING GAS PRICES HURT THIS?

Considering all the unrest and trouble that China has recently suffered in T*b*t, and with increasingly loud voices calling for accountability in the construction of school buildings, China wants to avoid more unrest.

With inflation at around 8 percent on the year already, and likely to climb higher, increasing prices for gasoline and ending subsidies can send that rocketing even faster. China’s low per person GDP means that non-subsidized gas will negatively effect farmers, and small businesspeople disproportionately. This could cut into entrepreneurialship and send some to protest, like people have already done in India and Malaysia where “the pump price of gasoline rose Thursday by a whopping 41 percent to 87 cents a liter, or $3.30 a gallon.”

The question is, will gas shortages, caused by undersupply (due to price controls) result in more unrest than raising prices. It appears that as far as the Chinese leadership is concerned, they believe it is better to keep prices low, considering all the other hits to the world economy.

Therefore, I predict that if gas prices in China rise before the Olympics, they will rise much less than they have elsewhere in the world. More likely, the prices will be raised after the Olympic ceremonies are complete.