- The PBoC has again raised the Chinese RRR - There is some evidence of slowing in the short term - Liquidity nevertheless remains little changed - Beijing is unlikely to go hard on interest rate rises

By Greg Peel

This week's Chinese “data dump” showed April CPI inflation had slipped to an annual rate of 5.3% from 5.4%. It is Beijing's intention to contain inflation but while this result might suggest success, it doesn't. Apart from exceeding forecasts of 5.2% on the annual rate, the month on month CPI actually ticked up by 0.1%.

Economists are thus little surprised that the People's Bank of China has again moved swiftly to raise the required reserve ratio for China's larger banks by another 50 basis points to 21% – close to the 1984 record. By increasing the level of capital reserves held by banks, the PBoC is preventing that money from being lent into the economy, and specifically to property developers. The PBoC has now raised the RRR by 0.5% five times in 2011 following six hikes in 2010.

The central bank has also made sporadic increases to interest rates in its efforts to slow growth and avoid an inflation blow-out, or worse – a boom/bust. China's booming property market is in the cross-hairs and in his recent Golden Week speech, Premier Wen clearly expressed that a price decrease in overheated cities is the target of policy tightening, Citi analysts note. The analysts have noted through their anecdotal assessments that a lot of project launches have had to be postponed.

Among the data dump numbers was national property sales growth figure which fell to 13.3% year-to-date from 14.9% in March.

The problem is, however, as the ANZ economists suggest, that “while an RRR hike has an immediate impact on banking liquidity, it is not effective in managing inflation expectations”. The reality is that a failure to raise interest rates, which implies a raise in both lending and deposit rates, means rising inflation has sent real deposit rates further into the negative. The result is Chinese savers are moving their deposits out of banks.

On the other hand, the expectation of higher interest rates encourages a further flow of “hot money” into China – speculative foreign investment looking to cash in on inevitable currency revaluation. This makes economic growth harder to constrain.

Despite the constant RRR hikes, more than one economist notes that the PBoC has continued to inject liquidity into the system anyway through open market operations, with the result being little change to total liquidity. A rate rise would effectively mean the PBoC withdraws liquidity.

Increasing the pace of renminbi appreciation would help slow growth and lower “imported inflation”, notes ANZ. The renminbi is pegged to the US dollar, so unlike, for example, Australia, China feels the full impact of commodity price rises resulting from loose US monetary policy. Only last week US heavyweights were in Beijing delicately urging expedience yet again, but the more Washington tells Beijing what to do the less likely Beijing is to respond.

The hot money issue has BA-Merrill Lynch economists suggesting the chances of more interest rate hikes is low, while ANZ is tipping a hike this month. JP Morgan analysts see the potential for two more hikes this year to correct negative real deposit rates and further RMB appreciation. Goldman Sachs believes Beijing will simply let the RMB appreciate against the dollar at the current 6%pa pace.

A lack of consensus among economists, although nothing new, does serve to emphasise the difficult position Chinese monetary authorities are in.

The good news is that the “boomy” pace of Chinese industrial production growth has been easing since the beginning of the year, JP Morgan notes. JPM expects retail sales and auto sales to moderate in the near-term. Looking ahead however, solid employment growth should lead to wage gains and thus overall consumer demand growth. Private property development will slow but only to be offset by increasing government projects.

The issue here is that the global market fears too rapid a Chinese slowing, and thus quivers every time Beijing does raise interest rates or looks like it might. Commodity prices are usually first to post a negative response.

But consensus among economists is that there is little to fear in the way of dangerous Chinese slowing, and thus fears over further tightening are largely unwarranted. All economists expect the pace of RRR hikes to be ongoing but the blunter tool of interest rate increases will not be wielded too indiscriminately.

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