No pills to treat Beijing's headache over required reserves
Beijing bureaucrats are in a bind over policy perils resulting from high required reserves
Beijing's relaxation of interest rate controls has left cutting banks' required reserves as the chief monetary tool to counter a slowdown, focusing attention on an option used in the past decade only during financial crises.
SCMP, April 26
Once again we have the bureaucrats in Beijing pretending to be in calm, masterful control of the economy while in practice they are frantically rushing from leak to leak in a dam that always threatens to break.
Statutory reserves are an old-fashioned tool of monetary control. The idea is that every time you make a deposit your bank sets a small proportion of it aside with your economy's central bank where it remains unused. This acts as a necessary brake on the circulation of money.
But central banks these days mostly use more flexible tools for the purpose, such as capital adequacy ratios for lenders, discount interest rates for advances to commercial banks and open market operations to purchase or sell government debt.
A rising number of countries including Britain, Canada and Australia have now abolished statutory reserves as no longer needed, while in the United States they are imposed only on checking accounts and in the entire euro zone the required level is only 1 per cent.
In China the current figure is an average of 19.5 per cent.
Yes, why? The answer is that in China the statutory reserve requirement is not really a tool of monetary control. It is a way of staving off the repercussions of rigging the foreign exchange rate of a country that has become the world's biggest noise in foreign trade.
I have to confess that I do not really understand the reasoning. I think it holds that a surplus is good and a deficit is bad and therefore we must have a balance of payments surplus, the bigger the better, because this means that we are earning money.
What it means in practice is a huge inflow of foreign currency, mostly US dollars, as the value of goods exported abroad far exceeds the value of goods imported from abroad.
And now what do we do with all these US dollars? Hmmm ... can't just have them sloshing around in China where they cannot be used. Best mop them up by taking them from the exporters who hold them and giving these people yuan in exchange.
But where do we get the yuan? Hmmm ... got an idea. We shall make the banks give us the yuan by taking it out of them through statutory reserve requirements.
Hence a reserve requirement that in eight years has risen all the way from 7.5 per cent to 19.5 per cent. In money terms, this now amounts to 27.8 trillion yuan (HK$34.9 trillion) placed with People's Bank of China. That's right, trillion yuan, not billion yuan, and we have two digits to the left of the decimal here. Gargantuan doesn't begin to describe it.
One resulting headache is that the US$4 trillion of foreign reserves this has bought translates at current exchange rates to only 23.4 trillion because the yuan has gone up against the US dollar. But the PBOC is reluctant to tell you this. The shortfall would reveal a deficit on its balance sheet equivalent to about 150 times its capital. Central banks don't go bust. They can always print money. Lucky for the PBOC.
Another headache, this one for commercial banks, is that the PBOC pays them an interest rate of only 1.62 per cent on their 27.8 trillion yuan of reserves. This did not matter so much when the commercial banks in turn could squeeze their deposit rates down to virtually nothing.
But now there has been a measure of interest rate reform and their cost of deposit funds is rising fast. For every 1 per cent that it rises over what they get on their reserves they lose 275 billion yuan a year. I think it is well past 1 per cent now.
And the irony of it all is that these statutory reserves have no monetary effect at all. They would only do so if kept cold in the PBOC's vaults, but instead they are pumped straight back out in the market.
No, I don't have any headache medicine to offer here. The Beijing bureaucrats are in a fix, a bad one, and I can't see a way out.