Central bankers are not noted as being wide-eyed optimists at the best of times. China’s are living up to the stereotype. The world’s investors are regaining some of their animal spirits on the strength of new signs that the slowdown in China’s economy is at last ending, but China’s central bankers are striking an ultra-cautious note in their third-quarter monetary policy report.
They warn that global demand could slump again unless the crisis in the euro zone is sorted out, sending the world into a double-dip recession. As for China’s part of the world economy, ‘the foundation of an economic recovery is not yet solid”. The People’s Bank of China’s policy focus will emphasize growth, but monetary policy will remain “prudent”.
The central bank fears that measures to promote domestic consumption are potential inflationary, even though inflation is subdued despite rising energy prices and labour costs. Year-on-year consumer price inflation was 1.9% in September, down from 2% the previous month.
No mention of further cuts in interest rates or banks’ reserve requirements. Playing with the short-term liquidity taps, as was done with the $60 billion injection into the money markets earlier this week, is the sort of open-market operation the central bank now prefers to “fine-tune” the economy, regardless of the risk of more volatile short-term interest rates. It is a way to talk tight but act loose, and still be able to switch back to acting tight at short notice.
More confirmation that the economy is maintaining its momentum, and policymakers a degree of nervousness. The People’s Bank of China has again raised its capital reserve requirement for the big banks, the sixth and latest of its step increases as the central bank continues to tighten monetary policy. The capital reserve ratio will be increased to a record 21.5% from June 20th.
The central bank made the announcement in the immediate aftermath of the publication of May’s consumer price inflation number, which at 5.5% is the highest in almost three years. The one following the other so quickly was unusual, but the central bank may have been attempting a little inflation expectation management combined with sopping up some of the foreign-exchange inflows that will have come with a resumption of trade surpluses in April and May. Nonetheless, the inflation number may be of more pressing political than economic concern, if the weekend’s riots in Zengcheng are any indication. Food price inflation in May was 11.7%.
The economy’s growth is moderating in a far more comfortable way for policymakers as the rate of new bank lending and money-supply growth is slowly but surely reined in. May’s greater than expected rise in industrial production and the slight rise in retail sales also suggests that the economy is maintaining enough momentum to take another step rise in interest rates, which would be the fifth since last September, in its stride.
China’s anti-inflation ratchet is clicking ever more frequently. The People’s Bank of China is again raising banks’ capital reserve-ratios. An increase of half a percentage point will come into effect on February 24th, taking the ratio to 19.5% for most large banks, and 20% for some.
It is the second time this year that the reserve ratio has been raised and eighth time over the past two years. It follows an increase in benchmark interest rates earlier this month (the third since the central bank started raising rates last October) and a January consumer price inflation number, 4.9%, which dashed any lingering hopes that inflation had peaked last November.
The central bank has been struggling to drain off the excess liquidity in the system. New bank lending in January was 1.04 billion yuan ($158 billion). The early months of the year tend to see a surge in new lending as banks clear their backlog of applications held from the previous month so they could stay in touch with their annual lending quota. But on top of the growing trade surplus swelling China’s foreign-exchange reserves and the yuan not appreciating that quickly to compensate, this means the central bank is facing an uphill battle to sterilize all those funds. We expect the click-click of the ratchet to continue.
Another twist of the anti-inflation ratchet: The People’s Bank of China says it will raise its benchmark one-year lending rate to 6.06% from 5.81% from February 9th. Its one-year deposit rate will rise to 3% from 2.75%. It is the third hike in interest rates since October. The relatively larger increase in the deposit rate suggests the central bank is trying to reverse the negative real savings rate, though it is moot whether that will make bank deposits a preferable investment to real estate or equities for most Chinese.
With consumer price inflation not having peaked last November as hoped but estimated to have risen again in January to 5.3% from 4.6% in December and the economy growing robustly the central bank has the scope to step up its fight against inflation. More step rate rises and increases in the banks’ capital reserve ratios this year are a racing certainty. So, to our mind, is greater use of yuan appreciation as an anti-inflation tool. We expect the benchmark lending rate to be kicking 7.0% by year’s end, and the yuan to have appreciated by 10% in real terms.
More evidence of the growing concern about inflation among China’s economic policymakers. The People’s Bank of China announced another rise in the reserve requirements for banks only hours after word of October’s larger than forecast trade surplus, at $27.1 billion. A 0.5% increase to 18% will come into effect on Nov. 16.
This is a move to drain liquidity from the system more than one to fatten the banks’ cushion against bad debts. Inflation in October is thought to have hit 4% year-on-year, a two year high. Few officials now expect the full-year number to come in anything but above the 3% target. Hot money from investors speculating on the yuan’s revaluation, foreign exchange reserves that now top $2.6 trillion and the side wash from quantitative easing elsewhere all risk reinflating the asset bubbles that the central bank has been working hard to let down without mishap.
Liquidity management has forced itself to the center of the central bank’s policy concerns. While this was the fourth rise in reserve ratios this year, we believe a further rise in benchmark interest rates to follow last month’s surprise increase, the first in nearly three years, is also likely sooner rather than later.
The Chinese central bank’s move to raise interest rates was unexpected. Policymakers are getting more nervy about the inflation risk and inflows of hot money.
The rate rises, the first since before the global financial crisis hit in 2008, lift the one-year lending rate a quarter of a percentage point to 5.56% and the deposit rate by a similar amount to 2.5%. We would not be surprised if they turn out to be the first of a series of modest rises over the coming year to 18 months as the central bank starts to mop up the excess liquidity that fueled the re-acceleration of growth following last year’s slowdown. Last week, the central bank increased reserve ratios for selected banks.
The next set of monthly figures are likely to show consumer prices rising at their fastest pace in a couple of years at 3.6% for September and that the third-quarter GDP figure may be stronger than the 9.5% growth expected, but the rate increases are better considered as part of the attempt to dampen a prospective asset bubble, particularly in real estate where we have seen a number of recent measures to curb demand and reduce the obdurately high levels of loans still flowing into property markets. Negative real interest rates would only exacerbate the flow of money out of bank savings and into hard assets, so the central bank has to get ahead of the inflation figures with its deposit rates.
But what is given to policymakers with one hand is taken away with another. Higher rates will encourage more capital inflows from abroad, inflows the People’s Bank of China is already concerned will be swollen by the U.S. Federal Reserve’s expected second round of quantitative easing. And that will put more pressure on the yuan for an upward revaluation, adding further layers of both economic and political complexity to the management of the economy.
It does, however, provide Beijing with a convenient excuse for letting the currency move up ahead of next weekend’s G-20 finance ministers’ meeting without appearing to be bowing to international pressure to do so. We can only wish, too, that it will also help the world get away from the sterile debate over currency wars.
Word is abroad that Beijing is imposing a ceiling of 7 trillion-7.5 trillion yuan ($1 trillion-1.1 trillion) on new bank lending in 2010. The lower end of the range was mentioned at a banking seminar (and then was denied as a slip of the tongue) and the higher end has been reported by China Securities Journal quoting unnamed sources.
The central bank has yet to announce its new-loans target for the year which would have been set at the annual top-level economic policy meeting in December. It had been expected following that meeting that new lending would be capped at 8 trillion yuan for 2010, so the new lower numbers have caused a stir, sufficient to knock 2% off shares on the Shanghai exchange Wednesday.
New lending in the first 11 months of 2009 was 9.2 trillion yuan, 5 trillion yuan up on the corresponding period of 2008, and blowing through the central bank’s 2009 target for the year as a whole as stimulus money was pumped into the economy. So the annual target is more symbolic than substantive and 500 billion yuan either way wouldn’t really make much difference given that the intention to rein in lending had already been given. Beijing has said it will continue to keep monetary policy loose in 2010 to ensure there is ample liquidity to keep growth going, but the central bank has been quietly tightening of credit gently since late autumn last year so inflation expectations don’t get out of hand.