China Tightening Likely to Continue


"The trick will be taking the steam out of the asset bubbles without causing a crash."

Expect more tightening of lending limits in China after the Chinese New Year. The exact amount will be down to the extent that price rises are seen to be feeding into the economy because the authorities' greatest fear is that runaway levels of lending in December and the start of January are fueling an unsustainable surge in investment—much of it speculative.

According to a Reuters article, the official PMI reached a 20-month high in December while an index derived from a companion poll by HSBC scaled an all-time high in January. Beijing’s loan quota for all of 2010 is 7.5 trillion yuan but banks loaned 15% of it in the first two weeks of January alone. Fortunately, the authorities in a command economy have more direct means at their disposal than tweaking interest rates or reserve requirements. Following direct orders from on high, banks reigned in lending from 1.1tn ($161bn) in the first half of January to 1.45tn ($212bn) by the 19th of the month and 1.6tn (234bn) by the month end. With the Chinese New Year now imminent the banks and the markets can pause for breath before they return later in the month. If necessary, the banks will be squeezed further by increasing reserve requirements again. The half point increase in required reserves that took effect on Jan. 18 locked up 300 billion yuan and at the same time initiated a much needed selloff in metals and equities—arguably both had lost sight of fundamentals. Beijing is more likely to increase reserve requirements again than raise interest rates at this stage. Bank lending is the primary worry and many industries are still struggling, so raising interest rates above the current one-year benchmark deposit rate of 2.25% is thought unlikely.

The trick will be taking the steam out of the asset bubbles without causing a crash. The current adjustments are in the right direction and so far at a manageable pace. The greater worry is less liquid markets. The question is: will banks make the decisions for speculators by restricting lending and starving markets of the oxygen they need to keep expanding?

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