Fighting inflation with checks and interferences

The People's Bank of China recently announced various measures to combat inflation. How effective will they be? Let's start with a story.

It was late June. I was chatting with a mainland punter about the stock market, with lacklustre trading showing in both the indices and turnover. 'The market will be alive again in a week's time,' he said.

He did not have a crystal ball but a good understanding of the monitoring processes of the banking regulators and their mid-year checks on bank loan growth. Banks had been urging their customers either to make handsome deposits to earn attractive rates before June 30, or not to draw any money before July 1.

'Call it a nationwide deposit campaign,' the punter said. The sole purpose was to make up a decent deposit-to-loan ratio and satisfy the regulators. Once the checks were over, everything would be back to normal.

Believe it or not, the market did rebound in early July. Is that a result of 'things getting back to normal?' No one can tell. But one thing is for sure. Mainlanders are maestros at playing the cat-and-mouse game. Regulations and official lending ceilings are there to be circumvented.

Combine this skill with controlled interest rates and therefore protected profit and you have banks with an eye only on asset growth, eye-popping loan growth and climbing inflation. In the first 11 months of last year, new yuan-denominated loans exceeded 99 per cent of the government's 7.5 trillion yuan (HK$8.78 trillion) limit. Analysts expect the figure for the year will reach 8 trillion yuan. To combat this trend, administrative interference is always the quick fix. Interest-rate reform and the building of risk awareness is too long term and remote a solution to help.

So instead of mid-year or annual checks, regulators will now do monthly inspections on the credit and capital levels of commercial banks. Instead of the China Banking Regulatory Commission - whose main job is not to combat inflation - the central bank will do the checks. Banks that fail the test will be ordered to set aside more reserves, with a lower interest rate from the central bank for the money set aside.

What really matters here is not the loss of some interest income but the pressure that comes with a monthly check. With daddy dropping in every month, one cannot go too wild. How big a 'nationwide deposit campaign' can banks undertake every month to dress up their books? This is not to mention the career repercussions for those senior civil-servants-cum-bankers for failing the test. All these tie in well with the ambiguity that comes with the lack of a loan growth ceiling for this year.

Instead of announcing a figure as it had done for years, the central bank will control loan growth according to economic conditions, the media reported. The official ceiling is there to be exceeded, so the saying goes. To bankers, the ceiling is like a ready-cooked turkey on the table to be carved. The faster you grab it, the better.

The absence of a figure plus a monthly check means greater uncertainty for bankers and more room to maneuovre for regulators. Theoretically all of these moves will give the central bank a better grip on credit growth. However, as with any administrative interference, their effectiveness is subject to compromise and negotiation.

The tug of war between the central bank and the major state-owned lenders - which are no less if not more powerful - has been an ongoing one. One can see a sign of compromise in the introduction of a nine-month grace period before the penalty is implemented. A better understanding of the latest moves is that it is an appeal to everyone to behave over the next few months with the hope that inflation will drop by winter as seasonal factors kick in. No stick will be necessary by then.

In almost every attempt to cool lending in the past, Beijing has started with interest-rate increases. If that is futile, it makes administrative interference. Seeing more alarming economic figures, it then introduces draconian measures. The latest effort to combat inflation is no exception.

What is draconian? Wind the clock back to 2004. Wen Jiabao was made the premier less than a year earlier, the economy was overheating and various cooling measures have failed. One morning in May, trucks of State Council officials arrived at the Tieben steel plant in Jiangsu. Stop the project, they said. Tieben's boss was jailed; various local officials were arrested; 3 billion yuan in loans were written off; and the half-finished plant was left to rust for a year before being sold as scrap.

The episode was broadcasted nationwide that evening. Officials met at all levels to study the case. The investment and lending frenzy in the country stopped overnight - at least for some months. What we are seeing so far is nowhere near that.