China Ramps Up Infrastructure Spending

By Marc Chandler

There are several noteworthy developments from China.

The first, while still a bit sketchy, seems the most promising. President Hu Jintao 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 682 billion yuan (about $100 billion) in 23 new major infrastructure projects beginning this year.

This effort follows the 2.2 trillion yuan investment in 120 infrastructure projects in the 2000-2009 period.

The announcement seems to have coincided with the rekindling of the risk appetite and the lifting of the commodity currencies. Separate but related reports suggest China will cut the corporate tax for western regions to 15% from 25%.

Second, Nikkei reported that China dramatically expanded its Japanese government bond (JGB) holdings in recent months. Last year China appears to have sold a net 80 billion yen of Japanese government bonds.

In the first four months of this year, China appears to have bought 541 billion yen of Japanese government bonds, of which 200 billion yen appears to have been purchased in April alone.

The People's Bank of China was quick to respond that this was not a sign of it divesting euros. There are some 621 trillion yen of outstanding Japanese government bonds, so China's holdings are quite modest.

Foreign investors hold around 3% of the outstanding JGBs. Moreover, Japanese government figures suggest that 96% of China's purchases are for instruments with maturities of less than a year. China had bought a great deal of U.S. Treasury bills during the heart of the financial crisis. As they matured, China rolled about two-thirds of them 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 U.S. officials that may be slowing its ability to expand more in the U.S. This story might not have immediate market impact, but it could portend China's sovereign wealth fund taking stakes in U.S. companies.

Fourth, the initial public offering from China's Agricultural Bank is set to be completed Wednesday. This has distorted the money markets as funds locked up during the subscription period forced rates higher.

The completion of the IPO could free up funds and ease rates. The Agricultural Bank seeks to raise about $20 billion, and reports suggest that interest may be greater than $70 billion. Those who fail to secure their full allocation will receive funds back on July 9, 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 Monday and Tuesday. The pattern would suggest the yuan will rise Wednesday.

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