PBoC move suggests Beijing still cautious
People's Bank of China's latest move to increase bank deposit reserves suggested Beijing was cautious about raising interest rates and would use other tools to combat inflation as it tried to cool prices without choking off growth.
Action by PBoC came one day after the National Bureau of Statistics reported a 5.3 per cent rise in the consumer price index for April, significantly higher than the government's 4 per cent target for this year. But other data released on Wednesday showed slower activity in the world's second-biggest economy.
The New York-based Conference Board said that China's risk of an economic 'hard landing' might be easing as a leading indicator pointed to a sustained expansion this year. The research organisation's index rose 1 per cent in March to 157.
Unlike most major economies, China uses reserve requirements as its first line of defence against inflation. When the move takes effect on May 18, China's largest banks will face a 21 per cent reserve requirement, among the highest in the world. This is the fifth action this year after six hikes in 2010, each by 50 basis points. The US reserve requirement for banks is 10 per cent. The PBoC raised interest rates twice this year and four times since last year, each a 0.25-percentage-point boost.
Most economists believed that Beijing prefers to raise reserve requirements rather than interest rates, and they are forecasting several more such actions. But some also question the effectiveness of the tool.
Ting Lu, an economist on emerging Asia at Bank of America Merrill Lynch, said that raising the reserve requirement 'is simple and can deliver policy intention to tame inflation, though it has little direct impact on the real economy and inflation'.
'We believe the room for further rate hikes is quite small this year on concerns of hot money inflows and economic growth,' he said.
Premier Wen Jiabao expressed concern over abundant interbank liquidity as the culprit of inflation.
Lu said a major source of liquidity was hot money inflows and domestic conversion of foreign exchange into yuan, which quickened on expectations of a strong appreciation of the yuan and higher interest rates.
Lu said China's foreign exchange reserves reached US$3.05 trillion at the end of March. That was up US$198 billion in the first quarter, of which US$139 billion could be 'unexplained inflows'.
Tim Condon, chief Asia economist with ING, said reserve requirement hikes were one thing, but hikes in policy interest rates required State Council approval. 'The soft tone of the April activity data will make such approval harder to obtain,' he said.
Peng Wensheng, chief economist with China International Capital Corp, said that as a substantial amount of central bank bills and repos, or repurchase agreements, came due, the reserve requirement hike would help to control interbank market liquidity. 'The interbank market interest rate dropped in the past two weeks indicating that abundant liquidity remains in the market,' Peng said.
Grace Ng, a China economist with JPMorgan Chase Bank, said, technically, reserve requirement increases remained a cheaper and more high-profile move than open market operations for liquidity management, as one-year PBoC bills yielded 3.3058 per cent versus 1.62 per cent interest on required reserves.
Ng also pointed to the fact that the amount of PBoC bills to mature in the near term remained elevated - 480 billion yuan (HK$574 billion) over the next five weeks.
'As such, on technical, open market operation considerations, an RRR hike is still an important tool for near-term liquidity management,' Ng said.
China is wary of raising interest rates directly - the preferred anti-inflation instrument in much of the world. Such increases work across the economy to slow activity, with less credit-worthy customers facing the toughest time, whatever the size of the companies.
China's benchmark one-year lending rate is just 6.31 per cent, about one percentage point higher than expected inflation, which is considered a relatively modest constraint to lending.
But analysts said that the effectiveness of the tool was declining as it was essentially another measure of capital or trade inflows.
'In this cycle, every time there was a big surge in this data, the central bank raised the RRR,' said Wei Yao, China economist with Societe Generale's Global Research and Strategy unit.
Yao said the quantitative tightening tools at PBoC's disposal would not be sufficient to sterilise even 80 percent of any additional liquidity from capital inflows.
China uses hikes in reserve requirements to fight rising inflation
The number of times Beijing has taken action this year and last is: 11