Learn Chinese: Chinese School - China seeks to curtail lending to prevent inflation

WORLD / Wall Street Journal Exclusive

China seeks to curtail lending to prevent inflation
By JAMES T. AREDDY (WSJ)
Updated: 2006-06-19 08:20

http://online.wsj.com/public/article/SB115046775124382390-imldtklZudouSeYYw
lES47fsj3c_20060623.html?mod=regionallinks

SHANGHAI -- China's latest credit tightening could push the country's
financial markets lower in a critical week that will see domestic pricing
of a stock offer by Bank of China Ltd., the biggest ever initial public
offering in mainland China. Less clear is whether it will have the
intended effect: curbing Chinese bank lending to damp torrid economic
growth and head off any resulting inflationary pressures.

The move, the second since April aimed at slowing the world's largest and
fastest-growing developing economy, sent ripples of concern Friday
through international markets, causing the dollar to strengthen briefly.
A slowing of the economy could soften commodity prices and crimp some
multinationals' sales in China. In China, it could dent a stock market
that is off its high for 2006, though the benchmark Shanghai Composite
Index is still up 36% so far this year.

China's central bank, the People's Bank of China, said late Friday it
will lift its reserve-requirement ratio for commercial banks, effective
early next month, by a half percentage point to 8%. The reserve
requirement targets the amount of deposits that banks must set aside
instead of lend; a bank holding deposits of the equivalent of $100 would
have to set aside $8 in reserves, thus limiting the amount it can lend.

"It's just freezing the liquidity," said Jonathan Anderson, UBS AG's
chief regional economist in Hong Kong. "The real impact is to get banks
to start slowing" their lending.

Still, analysts expect prices of Chinese stocks and bonds to fall
initially as banks adjust their balance sheets to comply with the change.
"The A shares will drop a little [today] but will soon resume their
increases," said Hu Weidong, an analyst at Xiangcai Securities Co. in
Shanghai, who worries more about rising interest rates in the bond market.

A heavy drain of financial-system liquidity could cool demand for shares
in Bank of China being priced and offered for Chinese investors this
week, though analysts still anticipate strong interest for the Beijing
bank's stock.

Bank of China is expected to set the pricing Thursday for its offer of as
much as $2.5 billion in Class A shares for the Shanghai market. The offer
will supplement this month's $11.2 billion IPO in Hong Kong.

Tighter credit coupled with recent gains in the yuan and new rules on
property speculation reflect how China's leaders are increasingly
concerned that a surge of loans is prompting excessive investment, which
in turn could spill over to higher prices. A raft of financial data
during the past week pointed to quickening growth and possible inflation,
despite an increase in lending rates in April.

For instance, the central bank said its key money-supply measure expanded
19% in May from a year earlier, while lending in yuan increased 16% in
May. The rates were some of the highest in two years. China's economy
grew at a rate of 10.3% in the first quarter.

With increased lending, investment levels are surging. Fixed-asset
investment jumped 30% during the first five months of this year, the
government reported last week. As investment in new factories and
property rises, so do risks the projects will incur losses and bank loans
will go bad.

Banks provide almost all of the financing in China's economy, and China's
top leaders openly called on them to slow lending after the past week's
economic data. "The fast growth in the fixed-asset investment should be
firmly curbed," Premier Wen Jiabao said last week.

Authorities are particularly concerned with overinvestment in risky
industries such as property. Manufacturing is another worry, as
increasing numbers of factories are driving up China's costs of importing
energy and raw materials.

China's surprise April increase in lending rates was the first boost
since late 2004, and the move -- the benchmark one-year-loan rate rose
0.27 percentage point to 5.58% -- signaled to economists that the
government will address fast growth with market-oriented measures.
However, the May data reported in the past week strongly suggested the
higher interest costs had little impact in curtailing borrower demand for
loans.

In contrast, the reserve requirement takes cash out of the system at its
source -- the banks -- and it has traditionally had a stronger effect on
bank behavior than other credit-tightening moves. It was raised most
recently in April 2004 and September 2003. The central bank says the
latest increase will remove the equivalent of $18.75 billion from the
banking system but won't take effect until July 5, a time gap that likely
reflects the jostling that banks need to do to adhere to the policy.

The instrument is "blunt," but "its effectiveness tends to be eroded very
quickly," Goldman Sachs economist Hong Liang said in a report. Yu Kai, an
analyst at Newland Securities Co. in Wuhan, said the stock market "has
been talking on it since this May, and the market performance has already
reflected these expectations."

Today, Chinese banks could sell domestic bonds to raise cash, which also
would signal higher interest rates in the country's debt markets. China's
market interest rates already have been creeping up this year, partly in
anticipation of more tightening, with one-year central-bank bills
fetching as much as 2.48% last week, compared with 1.9% at the beginning
of 2006.

Banks in China lend so freely because of their large deposit base, and
figures suggest most are well able to adhere to the new reserve
requirement. On average at the end of March, China's banks had placed
10.5% of total customer deposits of nearly $4 trillion at the central
bank, above the new regulatory minimum reserve requirement of 8%. But
weaker banks believed to be doing the most speculative lending might be
more severely affected, partly because higher reserve ratios apply to
them. In addition, banks have far lower excess reserves on average than
they did before the 2003 ratio increase was announced -- a move that
briefly sent overnight interest rates above 15% in China as banks
scrambled to raise cash by selling bonds.

U.S. stocks initially fell Friday as investors worried that China's move
to slow lending could affect corporate earnings. The Dow Jones Industrial
Average edged down 0.64 point to 11014.55.

Mr. Anderson of UBS said investors shouldn't be concerned that Chinese
authorities are trying to slow the economy so much as they are braking
its recent "accelerationist" tendencies. He said an increase in reserves
was expected.

China also has been taking less-market-oriented steps to cool the
economy, in particular by adjusting rules in ways designed to make
property speculation less appealing.

Meanwhile, China has been permitting the yuan to rise more quickly in
recent days, another possible effort to tighten credit in the financial
system.

In Shanghai currency trading late Friday, the U.S. dollar was at 7.9992
yuan, after trading in a range of 7.9970 yuan and 8.0007 yuan. While not
significant in the context of global currency-exchange movements, the
level of eight yuan to the dollar is a psychologically important point
that the currency market tested in three of five sessions last week.

As the yuan rises, it makes China's exports more expensive in U.S. dollar
terms. The U.S. administration has argued that a stronger yuan helps
reduce China's trade surplus.

Citigroup Inc. economist Yiping Huang said a rising yuan will be used
along with higher interest rates and other measures to cool China's
economy. "Accelerated appreciation of the [yuan] now looks inevitable,"
he said in a note Friday.

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Thursday, March 20, 2008

Chinese School - China seeks to curtail lending to prevent inflation

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