The global setting has changed a lot, and China in many senses is at the centre of it. In 2006, it had a current account surplus of $250 billion or 9.5% of GDP. In 2007, the first four months saw China’s trade surplus rise to $63 billion, an increase of 88% over the same period last year. In the light of this, many see the current account surplus for 2007 going to $400 billion or a staggering 13% of GDP. Add to this the capital inflows—FDI, portfolio investment and other flows—and the People’s Bank may have to purchase over $500 billion this year to prevent the renminibi from appreciating; ipso facto, to support the US dollar.

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The US Treasury Secretary is skipping the forthcoming G8 meeting of finance ministers in Potsdam this week. He will, instead, be preparing to meet the visiting Chinese delegation, part of the Strategic Economic Dialogue with China. There are no indications of any sign of slowdown in China, notwithstanding the efforts of its authorities. The economy grew by 11.1% in the first quarter and investment in fixed assets rose by 25%. Recent surveys conducted amongst 59,000 urban and 68,000 rural households show that real incomes rose by 16.6% and 12.1% in urban and rural areas, respectively, over the past year. Real consumption expenditure rose by 13.9% in urban households. Inflation has inched up to 3%, consumer food prices are up 7% and the Japanese-style corporate goods index showed inflation at 4.5% in February 2007.

The official data provides foreign exchange reserves up to September 2006 ($988 billion), though it is known that the reserve position is now over $1,200 billion. It is not known how much of the massive intervention was sterilised and how much was monetised. The cash reserve requirement is already at 11%. How much further can it go? Nor does anyone have an idea of how the central bank will manage the monetary implications of the expected $500 billion intervention in 2007. Then what happens in 2008 and in 2009? There is evidence of financial repression—real interest rates on term deposits are negative and the gross spread between deposit and lending rates, which are way too low, is over 350 basis points.

But the new manager of China’s trillion dollar foreign exchange reserves is buying not just treasury bills, but commodity futures in oil, copper, zinc and what have you

A recent official report claimed that a further 5-10% appreciation of the currency would bring ruin to tens of millions of factory workers and farmers—suggesting weak profitability of businesses that have created this giant export machine. Add to this the surging stock prices in Shanghai, which have risen an unbelievable 130% since September 2006 and 165% year-on-year. It is reported that negative real interest rates on the available savings instruments have encouraged naïve domestic investors to rush into the bourses, while international investors (who are never naïve; they just have herd mentality) are taking positions to profit hugely from the asset gusher. This is not widely known, but the new manager of China’s trillion dollar foreign exchange reserves is buying not just treasury bills, but commodity futures in oil, copper, zinc and what have you.

This is a time of much flux. The monkey, of Chinese legend, is laying about with his mace and there is much contradiction and change afoot. It could almost be straight out of Mao.

—The author is economic advisor, Icra. These are his personal views