International | Feb 15 2010
By Greg Peel
Not everyone was shocked by China's move to again tighten bank lending on Friday. As FNArena noted on Thursday (China Has An Inflation Problem) the economists at ANZ had decided “urgent action” was required by authorities pretty soon on the basis of last week's various Chinese data releases. ANZ suggested “within the month”, but in retrospect it makes sense that China would make its move ahead of the week-long New Year celebrations, which closes all markets, rather than afterward.
Two moves to tighten bank lending in one month are nevertheless seen as “aggressive” by the economists at Danske Bank, and the timing of the second move on Friday caught most of the world by surprise. The People's Bank of China increased its requirement of China's large banks to hold deposits as reserves (as opposed to using them for loans) to 16.5% from 16.0%, and made the same move for smaller banks to 14.5%.
The PBoC has a reputation of many years of taking a softly-softly approach to monetary policy, never wishing to suddenly derail the economic miracle and thus implementing only incremental changes spread out over time. However, over the past couple of decades the Chinese authorities have shown their inexperience in such matters by allowing economic growth surges to run too far before delayed tightening has brought about sharp busts. This has meant a rock and roll ride for Chinese stock market investors over time.
China's last such experience came in the first half of 2008 at a time when the world assumed China was “decoupled” from US and Western economic problems, and a crashing US dollar sent commodity prices surging and Chinese consumer price inflation towards double digits. The result was crippling price rises for Chinese staples such as pork and rice, let alone fuel and raw materials for manufacturing. Now that China has spent 2009 trying to drag its own and the world's economies out of the GFC mire with massive domestic stimulus, the same dangers loom. Already it appears that this year's iron ore and coal contract prices could be anywhere between 50-100% higher than last year's.
So this time it would seem China is being more pro-active than re-active. Last week's data showed Chinese CPI actually falling in its growth rate in January, marking only a 1.5% rise to December's 1.9% rise. But the producer price index, which measures wholesale price rises as opposed to retail, jumped 4.3%. It's only a matter of time before such a jump flows through to the consumer.
In the meantime, surging levels of bank lending and a runaway property market have deja vu written all over them for the PboC, and given the boom is specifically related to government stimulus in form of money given to banks for the sole purpose of lending, what the Communist Party giveth the Communist Party can taketh away. Hence the increase in bank reserve requirements, which ostensibly builds protection against the risk of non-performing loans and slows down the lending frenzy.
Danske Bank suggests the tightening measures show China is now shifting its focus from supporting economic growth in haste to containing resultant price and asset inflation. The next step from here is to raise the cash rate and to allow the renminbi to further revalue against the US dollar. China's pegged currency is at the heart of CPI pressures given there is no floating mechanism to adjust to moves in the US dollar and dollar-denominated commodities.
Danske Bank had pencilled in cash rate and currency increases in the second quarter of 2010, but the economists now feel the adjustments will come sooner rather than later.
From Australia's perspective, any measures designed to slow the Chinese economy are not good news at a time when local economic growth is still tenuous and very much dependent on export partners. However, nor would Australia wish to enjoy a year or two of Chinese boom followed by a sharp bust. The simple fact that China is forced to temper its economic surge is testament to underlying strength which, if more sensibly managed, can ensure a more reliable, if not quite as spectacular, growth trend for years to come.