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UPDATED: May 10, 2010 NO. 19 MAY 13, 2010
Putting a Freeze on Liquidity
China raises its reserve requirement ratio for large banks to prevent its economy from overheating
By HU YUE
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Taming inflation fears

With China's economy bouncing back, inflation is no longer a theoretical side-effect of the lending surge so far, but a practical concern that needs to be tackled before it spirals out of control.

The consumer price index (CPI), a main gauge for inflation, grew a mild 2.2 percent from a year earlier in the first quarter. "But food prices, a major element of CPI, are braced for a run-up in the upcoming months due to buoyant demands and the drought in south China," said Guo Tianyong.

Meanwhile, the producer price index (PPI) has grown much faster. The PPI, a barometer for inflation at the wholesale level, rose 5.2 percent year on year in the first quarter of 2010. It will only take three to six months for the fast-growing PPI to ripple through consumer prices, so the policymakers need to take preemptive measures against inflationary risks, Guo said.

Dampening the property market

The ratio hike will also give a heavy blow to the white-hot property market. National Bureau of Statistics' data show house prices in 70 large and medium-sized cities surged a record 11.7 percent in March.

The past few weeks have seen the government take every measure possible to squeeze speculators out of the market. Among the most overwhelming policies were tighter mortgage rules, higher requirements for down payments and a stringent clampdown on financing for property developers. The avalanche of new policies is yielding results. The sales volume in April fell as buyers held off on purchasing houses in anticipation of price declines.

By striking the banks' ability to lend, the spike in required bank reserves will further drain life from the property fever, said Chen Guoqiang, Director of the Research Institute of the Real Estate Industry at Peking University.

The psychological impact on homebuyers, in particular, will be overwhelming, and expectations for price declines will take hold, said Chen. In the wake of a government clampdown on the real estate sector, most property developers have held onto peak prices or delayed sales of new houses, with a close watch over market situations. But the ratio hike will only prompt them to take actions to lure buyers either by lowering prices or stepping up promotional offers, added Chen.

Zhao Xijun agreed. Together with several previous austerity measures, the latest ratio adjustment will leave commercial banks little room for lending to property developers, and force the developers to lower prices, he said.

Interest rate hike?

Ba Shusong, a senior researcher at the Development Research Center of the State Council, said the latest ratio hike shows the central bank has no intention to raise the interest rate in the short term.

The central bank has preferred quantitative measures so far this year like open market operations and reserve requirement ratio adjustments, and is hesitant to move on the interest rate and currency exchange rate, said Ba.

"Policymakers will not take their foot off the accelerator since the woes of many crisis-stricken enterprises still need time to heal," said Lian Ping.

Moreover, an early interest rate hike ahead of Western countries could accelerate hot money inflow and disrupt domestic financial stability, he added.

But some experts consider an interest rate hike necessary.

"China still prefers to fine-tune credit conditions and the property market rather than using blunt instruments that impact the entire economy," said Brian Jackson, a Hong Kong-based strategist at the Royal Bank of Canada, in a recent report. "The danger is that the approach will not be enough to keep these price pressures under control, which would then force policymakers to tighten more aggressively later on."

Li Huiyong, an analyst with the Shanghai-based Shenyin & Wanguo Securities Co. Ltd., said a move from gentle tightening to actual interest rate increases will largely depend on whether inflationary expectations become inflationary realities.

Calming down the overheated economy would eventually require serious monetary tightening measures, such as interest rate hikes, said Li.

 

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