International | Jan 13 2010
By Andrew Nelson
The Peoples Bank of China (PBoC) has moved to increase the deposit reserve requirement ratio (RRR) for commercial banks by 50bp, with only rural credit cooperatives exempted from the new policy. The nation’s larger banks, which account for better than 50% of total deposits, will now be looking at a rate of 16%, while smaller ones see their RRR increased to 14%.
The move by the PBoC to lift the RRR is being read by many experts as the first phase of a new monetary tightening process, as it follows fast on the heels of increasing evidence that China’s growth is accelerating and inflationary pressures are starting to emerge.
Earlier in the week, China’s foreign trade data indicated a sharp increase in exports, with levels now returning to pre-GFC levels. Adding to the pressure, the output price component in the HSCB manufacturing PMI has now pushed back to levels not seen since summer 2008, when inflation was running pretty hot.
The main message of this move by the PBoC, speculates Danske Bank senior analyst Flemming J. Nielsen, is simply that monetary policy is shifting from supporting growth to containing inflation and preventing any troublesome bubbles that could emerge in financial markets. When looked at in conjunction with the recovery in exports, Nielsen believes the move is simply a necessary one to allow the gradual appreciation of the Chinese yuan against USD at some stage.
Nielsen sees the next step as being an eventual hike in the leading benchmark interest rate, with the resumption of a gradual appreciation of CNY manifesting itself as a second phase of the monetary tightening process. Nielsen sees this happening some time in Q2 this year. In the near-term, he predicts we’ll begin to see further administrative measures such as new lending guidances, which will be aimed at pushing money market interest rates higher, while there may also be another increase in RRR as well, he says.
On the other hand, UBS economist Tao Wang is of the opinion that the move doesn’t actually signal any sort of serious monetary tightening for the overall economy. He points out that China had been signalling a change in monetary policy since Q309, while it moved to set a much lower credit growth rate last month. Thus, he reasons, this latest move by the PBoC doesn’t actually mean that China’s credit growth target has really been tightened at all.
Wang thinks the hike will simply allow the Chinese government to achieve a number of consistent policy objectives in one fell swoop. Excess liquidity is drawn out of the market without having the heavy impact of a central bank bill issuance, while at the same time sending a clear signal about PBoC’s intention to be less accommodative. The move will also create a squeeze on riskier assets, while not affecting overall credit to the real economy.
Thus Wang arrives at the same conclusion, albeit via a slightly different route: It’s all about keeping a handle on the yuan, while still allowing the Chinese currency to rise (later).
While the November data aren’t out yet, Wang believes that FX inflows probably rose strongly, which will lead to an increase in base money supply. With exports recovering at a rate of naughts and CNY appreciation expectations rising, he believes that FX inflows will continue to get larger. This will require increased “sterilizing effort” by the PBoC, or in other words, says Wang, “the central bank has to keep running to stand still”.
Thus while the move by the PBoC to lift the RRR came somewhat sooner than either Wang or Nielsen expected, and while neither believe it will be the last RRR hike of the year, Wang believes the threat of another RRR increase will be almost as effective as one actually occurring. Macro data are expected to continue to get stronger, thus inflationary concerns will rise, meaning ever increasing concerns about policy tightening. Even without a looming threat of rising reserve rates.
This fear of imminent and more serious policy tightening will keep a lid on financial markets, while allowing China’s economic activity to remain buoyant, earnings growth to overshoot market expectation and see new bank lending get to about CNY 3 trillion, predicts Wang. Thus, much like Nielsen, Wang doesn’t expect any hike in benchmark interest rates in Q1, while he further expects to see no new quantitative controls on credit beyond what has already been announced any time soon.
UBS is maintaining its forecast that GDP growth in China will be at least 9% in 2010, with property and infrastructure investment helping to support growth in underlying demand for commodities. However, Wang admits that as banks try to front load lending to escape the expected tightening in H2, they may end up forcing the government’s hand earlier than expected, although this week’s moves may well have forestalled this.
