CDT Money: Uneasy Status Quo?

In a week dominated by the political drama surrounding the dismissal of embattled Chongqing party secretary Bo Xilai, speculation continued over possible monetary easing despite mixed messages from officials as they seek to stave off a hard landing for China’s economy.

A week after Premier Wen Jiabao opened the National People’s Congress by lowering China’s 2012 GDP growth target, and just two days after China announced its largest trade deficit in more than a decade, People’s Bank of China (PBOC) Governor Zhou Xiaochuan claimed in his annual press conference on Monday that “big room” existed for further cuts to China’s reserve requirement ratio (RRR). He cautioned that any RRR adjustments, however, would not signal a broad change in monetary policy but rather an attempt to control market liquidity amid fluctuating capital flows. Reuters published a transcript of highlights from the press conference:

“Now banks’ reserve requirement ratio is just over 20 percent. We had low RRR, which was at 6 percent in the late 1990s.”

“There is a lot of room for RRR cuts. But we need to look at whether it’s necessary… and look at market liquidity. We cannot raise or cut RRR at will when we think there is room. We need to look at the liquidity condition, which is related to FX purchases and our international balance of payments.”

“The PBOC has always paid attention to price tools. It raised the benchmark interest rate five times from the fourth quarter of 2010 to the third quarter 2011. But when we use the tool, we need to consider some constrains. One consideration is the impact on capital flows.”

A closer look at capital flows in China would indicate a greater possibility of further RRR cuts. In addition to the massive trade deficit, Wednesday’s announcement by the Ministry of Commerce that foreign direct investment had fallen for the fourth straight month puts added pressure on China to generate liquidity from within. But despite both slower inflation and an RRR cut in February that was expected to boost domestic lending capacity by almost 400 billion yuan, China’s banks fell well short of new yuan loan targets in the first two months of 2012. Preliminary estimates of new yuan loans for March, reported today by the China Securities Journal, would represent an increase from February but still result in a first quarter total that falls short of the 2.4 trillion yuan target.

While a fresh RRR cut may be on the horizon, officials at China’s big four banks said Wednesday that the industry’s China Banking Regulatory Commission (CBRC) had already taken other steps to ease lending capacity. From Bloomberg:

The regulator is letting the lenders use more of their deposits to make loans, the bank officials said, after China’s exports, industrial production and retail sales declined in the first two months. Loan growth has slowed this year as depositors seeking higher returns removed money from savings accounts and the economy’s expansion at the smallest pace in 10 quarters curtailed demand.

The banking regulator is increasing the 2012 loan-to- deposit ratio target for Industrial & Commercial Bank of China Ltd. to 63 percent, an official at the Beijing-based lender said, declining to be identified as the matter is private and yet to be finalized. He declined to provide last year’s figure. The measure was also raised at two rivals, officials at those banks said, declining to provide their 2012 targets.

“Deposit growth has been sluggish since late 2011 and severely constrained banks’ lending capacity this year,” said James Liu, a Hong Kong-based analyst at CIMB Securities HK Ltd. “The regulator wants to alleviate the problem by giving banks adequate resources to lend.”

Another method by which China may look to release more capital into the financial system, at least on a more legal basis, is through legitimizing its informal lending system. The South China Morning Post reported on Monday that delegates to the annual Chinese People’s Consultative Conference (CPPCC), which took place alongside the NPC in Beijing, had called for an end to underground or shadow lending, which may make up half of all new loans in China as the big state-owned banks chiefly lend money to state-owned enterprises. Entrepreneurs in Zhejiang, which has been the epicenter for the funding woes that have befallen private enterprises in China over the past year, echoed the calls of public officials.

Wen Jiabao’s comments in his wide-ranging closing press conference at the NPC indicate that the central government may be listening, according to The Wall Street Journal:

He said that China’s central bank and the China Banking Regulatory Commission are considering launching trial reforms of informal lending in the Chinese city of Wenzhou, a city with a reputation as a center of private enterprise and informal lending.

“We should guide and permit informal capital into the financial arena, standardizing it and bringing it into the open, encouraging its development and strengthening its supervision,” said Mr. Wen, who was speaking at a news conference marking the conclusion of the annual meeting of China’s legislature. He also said informal loans should have clear legal safeguards.

Wenzhou, in Zhejiang province, brought the funding pressures of China’s private sector into sharp relief late last year when Beijing tightened monetary conditions, making it even more difficult for the city’s small manufacturers to access credit or repay high rates of interest.

More than a dozen business owners shut their factories and skipped town, leaving their creditors behind, according to state media reports.

Spotlight: Yuan Near Equilibrium?

Of the other topics covered by Zhou Xiaochuan in his Monday press conference, observers also focused on his comments about China’s yuan exchange rate. Here, the Financial Times reports that Zhou stopped short of making any bold statements about renminbi appreciation going forward:

The central bank governor also dodged a question about whether the central bank had decided to halt the appreciation of China’s currency. “Generally speaking, as the renminbi exchange rate gets closer to the equilibrium point the market supply and demand should take a greater role – that is to say we should allow and encourage a greater role for market supply and demand,” he added.

A growing number of analysts point to China’s trade data, cross-border capital flows and slower accumulation of foreign exchange reserves as evidence that the renminbi is no longer grossly undervalued. “Fundamental surpluses have continued to narrow and the renminbi is closer to the equilibrium value than ever before,” said Paul Mackel, head of Asian currency research at HSBC. “This structural change in China’s balance of payments has profound implications for the currency.”

During his press conference on Wednesday, however, Wen Jiabao went a step further in suggesting that the renminbi may have already reached equilibrium:

The yuan has gained 30 percent in value in real terms since 2005 and has moved up and down since September in Hong Kong trading of nondeliverable forward contracts, Premier Wen Jiabao said. Such contracts are used by traders to bet on movement of currencies that are not freely traded. They are settled in dollars or other hard currencies.

“That shows that the renminbi exchange rate may possibly have reached an equilibrium exchange rate,” Wen said at a news conference at the end of China’s annual legislative session.

Wen pledged to create a more flexible, market-based exchange rate system, saying, “We welcome greater elasticity of the renminbi exchange rate.”

Time for Interest Rate Reform?

Reuters reports that public anger about rising bank profits, which mainly stems from the robust spread they earn by capping interest rates while setting a floor on lending rates, has put bank executives on the defensive while bolstering support for interest rate liberalization. The always-candid Li Daokui, who recently resigned his post as an adviser to the PBOC, said at a Saturday forum that enough support may exist for such reform. From The Wall Street Journal:

“We need market-oriented interest rates,” he said, adding that the time is right for such a move as part of an overall economic restructuring, which is now the key task for China.

“Banks have high profits, and we don’t need to worry about protecting them. They are like dinosaurs,” he said, suggesting that these “dinosaurs” were big but weren’t about to disappear.

Interest-rate liberalization has long been discussed for China’s state-managed financial sector, which is dominated by state-run banks and which relies on interest rates that are generally set under guidelines from the central bank.

But Mr. Li suggested that circumstances may be changing.

“I think there is tremendous support…within government for this.”

See also a China Daily video interview with Li on the subject, in which he says commercial banks should “lose weight.”

Premier-in-Waiting Touts Reform

After outgoing Premier Wen Jiabao used his Monday NPC press conference to push for bold reforms, Premier-in-waiting Li Keqiang sang a similar tune during a Sunday speech, promising flexible policies and structural reforms to keep up with an evolving economy. From Reuters:

“China has reached a crucial period in changing its economic model and (change) cannot be delayed. Reforms have entered a tough stage,” Li said, echoing comments made by Wen last week.

“We will make policies more targeted, flexible and forward-looking to maintain relatively fast economic growth and keep price levels basically stable,” Li said in a speech at an economic policy conference, attended by top Chinese officials, the head of the IMF and dozens of foreign business leaders.

He said China would “deepen reforms on taxes, the financial sector, prices, income distribution and seek breakthroughs in key areas to let market forces play a bigger role in resource allocation”.

Other News

  • Chinese stocks ended the week on a high note, buoyed by consumer companies on speculation that they will benefit from government emphasis on generating domestic demand.
  • The chairman of both China National Petroleum Corp (CNPC) and PetroChina told reporters on the sidelines of the NPC that China should raise fuel prices following the recent surge in the price of crude oil, according to Reuters. The former head of China’s National Energy Administration, however, says the time is not right and any hike in fuel prices will hurt Chinese consumers.
  • Tianjin boasted the highest GDP per capita (US$10,783) of China’s 31 provincial regions in 2011, beating out Shanghai and Beijing, according to The Global Times.
  • Rising green onion prices are causing a stir in some parts of China.
  • China set ambitious shale gas output targets in a development plan released Friday by the government. The plan, which runs through 2020, urges local companies to work with foreign companies as they exploit China’s national gas resources.
  • The Ministry of Commerce said China must “step up its efforts” to secure free trade agreements with the likes of Japan, South Korea and other neighbors in Asia Pacific. Meanwhile, a former MOC official asked why China hasn’t pursued a free trade agreement with the United States yet.
  • U.K. banks are lobbying the Bank of England to sign a currency-swap agreement with the People’s Bank of China, in an effort to make it easier for the banks to facilitate yuan liquidity. China has signed 1.3 trillion yuan of currency-swap deals with 14 countries and territories, according to The Wall Street Journal.