My Blog

April 17, 2008

THU 17 APR

Minimum reserve requirements jump to 16% By Michael Pettis

“Now, we not only have to prevent a sharp downturn of the economy, but also a rebound in investment,” Li Xiaochao, spokesperson for the National Bureau of Statistics, said in his comments yesterday.  He also said in the same release that “the top concern is still inflation.”

 

He’s right.  Not only were the inflation numbers pretty grim, as I see them, but fixed asset investment is up pretty substantially to RMB 2.185 trillion, for a 24.6% increase year on year, versus an already-high 23.7% increase over the same period one year ago.  Yesterday the State Council, which is chaired by Premier Wen, released a statement in which it said: "We need to closely watch the latest development of the economic situation, and strike a balance between promoting economic growth and curbing inflation.”

 

As regular readers know I am skeptical about the availability of policy tools that will permit a striking of this balance.  I think we have already passed the point of no return on inflation and monetary growth, and by now the only way to rein these in will almost certainly involve sacrificing employment in the short term.  The longer they wait, the greater will the needed sacrifice be.

 

Given attempts to cool things down what explains the jump in investment?  Credit Suisse says it is a new round of local government-driven infrastructure investment, which makes sense given that typically every five years, when the new leadership takes up their positions, their first actions tend to involve a significant jump in spending.  I am also hearing that some of the hot money inflow is showing up in the informal banking sector and being lent out.  I noted, but did not comment on, an article in the South China Morning Post five days ago that was titled “SMEs turn to underground lenders for cash.”  According to the article:

 

Beijing’s credit-tightening policy could have sent some cash-strapped small and medium-sized enterprises (SMEs) to seek costly funding from alternative financing channels - the underground.

 

“If their loan demand cannot be satisfied by the banking sector, companies will look to the non-banking financial sub-sector for funding,” said David Kiang, a vice-president for international corporate banking at Shenzhen Ping An Bank, a subsidiary of Ping An Insurance. Mr Kiang added that some hard-pressed businesses might have borrowed from mainland pawn shops, which lend sums against collaterals at high funding costs just as Hong Kong's money-lenders do.

 

…Beijing's policy to limit banks' loan growth also makes it harder for SMEs to borrow. Big banks traditionally prefer to lend to larger firms and have become even more selective now that the lending cap is in place.

 

This isn’t surprising at all and in fact several times over the past few months I have speculated that the informal banking sector would be taking up the lending slack.  I wish I knew of some way to track the sector.

 

At any rate, and as everyone knows (they slipped it in after I finished yesterday’s blog entry), the PBoC raised the minimum reserve requirement rate again, by 0.50% to 16%.  I expect that they are going to do this several more times this year.  Since most other “market-based” policies don’t seem to work or may even exacerbate weakness in the banking system or increase monetary inflows, this is likely to be one of their favorite solutions, although of course raising the minimum reserve does strain banking sector profitability and I think banks desperately need profits with which to help dig them out of their non-performing hole.  There are no easy solutions – every thing they give with one hand they take away with the other.

 

But I am not sure the raising the minimum reserve requirements will anyway make that much of a difference.  Each reserve hike drains about $20-25 billion from the system, but with currency reserves growing by about $50-90 billion a month so far this year (the wide range exists because we are not sure exactly by how much headline reserve growth needs to be adjusted to account for the full impact of net inflows, as I explained in my April 12 entry), we’re going to need a much more aggressive stance to reduce underlying liquidity, and with so much worry about excess slowing, I don’t expect we’ll get that level of aggressiveness.

 

By the way in today’s Wall Street Journal Asia I have an Op-Ed piece explaining why I think the low but rising inflation in the non-food part of the Chinese CPI is so worrying.  The basic argument is that if food prices were rising so quickly because of a supply problem, the fact of their rising would put so much downward pressure on the non-food sector that we would see severe deflation, or at least disinflation, in non-food prices.

 

In fact we are seeing low, but rising, inflation, which is inconsistent with the idea that this is just a food-supply problem.  It suggests that inflation is caused by excess money, and that the sudden partly coincidental jump in food prices has simply absorbed most of the inflationary pressure, thus keeping it from showing up in the non-food sector – until food prices stop rising.  You can find the full article at:

http://online.wsj.com/article/SB120838835562221079.html?mod=opinion_main_commentaries