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Jake Van Der Kamp

People's Bank of China governor Zhou Xiaochuan said fiscal tightening measures including rises in interest rates and banks' reserve ratios were the main tools the central bank would use to rein in inflation.

SCMP, March 12 

In case you wondered, the use of the word 'would' in the excerpt above is probably correct this time. It indicates a conditionality that I think really does exist here.

The word is often misused. It implies in this context that there is a missing clause beginning with the word 'if' in the sentence: he would use these tools to rein in inflation  if he could do so (but he can't or won't or will be stopped).

 Assuming, however, that there is no 'if' implied here, that Mr Zhou has no misgivings about his inflation-reining abilities and that everyone is certain he will carry out the job then he  will, not  would, use these tools to rein in inflation.

Okay, call me pedantic. I only make the point as a way of saying that 'would' is the correct word here because Mr Zhou may not actually be in a position to rein in inflation with these tools.

Start with those rises in the bank statutory reserve ratio, although 'start' is actually the wrong word here. These increases have been going on for a long time, as the first chart shows. The mandated reserve that commercial banks must now place with the People's Bank of China is 19 per cent of all deposits they take in.

This really does make the PBOC appear to be swinging a big stick. Statutory reserves are meant to be kept out of circulation, thus cooling the economy, and it's a wonder that a statutory reserve ratio of 19 per cent has not achieved this object by now.

That is to say it would be a wonder if the PBOC kept the money out of circulation. But, of course, it does not. It uses the money to buy up the US dollars that flow in from China's big trade surplus. The money thus goes right back into circulation immediately and there is no tightening effect at all. What we have here is a tool for rigging the yuan's exchange rate, not for controlling inflation.

More to the point, we are talking of a great deal of money. The PBOC's balance sheet shows liabilities to financial institutions of 13.7 trillion yuan (HK$16.16 trillion) at the end of last year. That's the statutory reserve requirement at work.

And now here comes the big question. What sort of interest rate does the PBOC pay these financial institutions on these liabilities?

Turn to the second chart. Yes, you have it, a miserable 1.62 per cent a year and I do not see any indication in this chart of interest rates going up.

This is actually not all that surprising when you realise that even 1.62 per cent yields interest payments of 222 billion yuan a year, which is more than 10 times as great as the PBOC's own capital.

Now I know that central banks do not go bust. They just print more money and adjust, shall we say, the way they present their figures. Even so, the PBOC's currency rigging exercises of recent years have given it a very peculiar-looking set of accounts.

What the PBOC would like is to see US interest rates go way up and yuan rates stay low. The higher returns on its US$2.8 trillion of foreign reserves would then make up to some degree for the mammoth  losses it has had to take in its home currency on all these foreign currency acquisitions.

I use the word 'would' correctly here. There is a big 'if'. This scenario is an unlikely one.

But it means that while the enthusiasm in Beijing for fighting inflation in the headlines remains as strong as ever, the prospect of doing it in reality is an unwelcome one. It might actually mean keeping reserves in reserve, for instance, and not only taking exchange rate losses on foreign reserves but net interest income losses too.

Yes, that will be a very daunting prospect. I think Mr Zhou will decide that discretion is the better part of valour when facing it.



Think of the daunting losses if mainland does fight inflation