Tightening The Monetary Policy Wrench

China’s tenth turn of the bank reserves ratio wrench was more vigorous than the previous ones but just as likely to be as ineffective. The People’s Bank of China said today that it will raise from December 25 the proportion of deposits that banks must hold in reserve by one percentage point to 14.5%. The nine previous increases were by half a percentage point.

This tightening of monetary policy will make $47 billion unavailable for lending, by the central bank’s reckoning. The move has been signaled earlier this week and goes hand in hand with five interest rate rises (expect a sixth before year’s end) and a freeze on net new lending for the remainder of this year. Quarterly lending quotas for banks are expected to replace annual ones for 2008.

Policy makers remain worried that the plentiful credit sloshing around the economy is only lifting up share and property prices in a way that can only end in tears — not the crying game that Beijing wants in Olympics year especially.

The central bank has been using increases in the reserve requirements as its main mop for the huge inflows of dollars coming into China from a record trade surplus and foreign direct investment inflows that have exceeded $1 billion a week for the past five years. But that flood of money is coming at it faster than it can mop. Ever higher reserve requirements have done little more than sterilize most of the domestic inflationary impact of the dollar inflows and the PBOC’s management of the yuan’s exchange rate.

But banks still have enough more than enough cash available for lending. So further turns of the wrench seem inevitable. A reserve requirement of 20% by the end of 2008 isn’t inconceivable along with more interest rate rises and administrative measures. But as central banks around the world learn the hard way, deflating a bubble gently is no easy matter.

2 Comments

Filed under Economy, Markets, Uncategorized

2 responses to “Tightening The Monetary Policy Wrench

  1. Miscel

    Why wasn’t tightening of reserve ratio effective ? Was it because the banks have not yet rich that ratio and there are still more room to lend before they hit the ceiling ? Was it because the rules about ratios were not enforced effectively ? Was it because there are many other ways to borrow money in additional to bank loans ? Was it because a lot of these investments and purchases finance through use of cash reserves (business and personal) ?

  2. China Bystander

    In part the answer is some of all of the above, but more importantly there is so much liquidity in the Chinese banking system from the current account surplus and it is expanding so quickly that the central bank just can’t mop it up fast enough.

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