Sunday, April 29, 2007

As many expected, the PBOC raised reserve requirements once again. This is done to control inflation....etc. Dear investors of Chinese commercial banks, this also squeezes the profit margins of banks. PBOC bonds, which is another way of soaking up liquidity, would have given banks a 3% yield, which is roughly 1.5% above the average deposit interest rates. In contrast, required reserves only pay 1.89%. As you can see, there is over 100 basis points in forgone profits. Conclusion: the more liquidity is soaked up by reserve requirement increases rather than by PBOC bond sales, the more bank profits are being squeezed. Mm, shouldn't the China Banking Association do some lobbying, complaining....etc.? What about foreign institutional investors? By the way, some are saying that a few more reserve requirement increases are expected this year.


ยท By Rick Carew and J.R. Wu

BEIJING -- For the seventh time in less than a year, China's central bank raised the share of deposits banks must keep on reserve as the government struggles to soak up capital and keep the country's economy from overheating.

The move, which was announced yesterday and takes effect May 15, follows accelerated economic growth and an uptick in inflation indicators. The government announced this month that gross domestic product, or the total value of goods and services produced, expanded at a faster-than-expected 11.1% in the first quarter.

Economists had expected the government to take further measures to tighten money supply around tomorrow's May Day holiday and said that in coming weeks the People's Bank of China could implement even more measures -- including a rate increase -- to contain upward pressure on prices and slow growth from the blistering pace of the first quarter.

The central bank said on its Web site yesterday that the increase in reserve ratio is aimed at "strengthening the management of liquidity in the banking system" and guiding "the reasonable growth of credit."

Still, economists said increases to the reserve ratio have so far achieved little, if any, of their desired effect. The newly announced increase will bring the reserve-requirement ratio -- the share of deposits that lenders must keep with the central bank -- up half a percentage point to 11% for most banks. The increase, in theory, reduces the amount available to banks to lend, though in practice many Chinese banks already keep more than the minimum on reserve.

"The past two years of experience in China has shown that [reserve-ratio] changes are an ineffective policy tool to control monetary expansion," Hong Liang, a Hong Kong-based Goldman Sachs economist, said in a research note after the increase was announced. Such ratio increases are "simply not binding on banks' capabilities to lend," Ms. Liang said.

Behind the flush liquidity in the domestic economy is China's booming trade surplus, or margin by which exports exceed imports, and the central bank's intervention to keep the value of the domestic currency from appreciating too quickly as a result. The central bank pays out yuan to banks to buy their dollars, pumping cash into the economy.

Because many investors believe the reserve-requirement increase signals the government's resolve to continue employing tightening measures, the move could cause traders to push domestic shares lower in trading today -- the last day China's markets are open before a weeklong holiday. But any selling is likely to be limited, analysts said.

"The People's Bank tightened at this juncture to give the markets a little time to digest this increase," said Jing Ulrich, chairwoman of China equities at J.P. Morgan & Co. "This one hike alone won't trigger a major selloff."

The acceleration in China's economic growth, driven in significant part by bank lending to new investment projects, has forced Beijing to pull a variety of monetary-policy levers since last year. It has also enacted administrative measures to cool sectors such as property and steel, which threaten to push prices higher. The latest reserve-ratio increase is the second in a month.

China's consumer-price index rose 3.3% in March and 2.7% in the first quarter, compared with a year earlier. That pickup has sparked concerns that after muted inflation in recent years, rising production capacity might no longer be able to counterbalance demand, and a surge in prices could be ahead for the world's fastest-growing major economy.

"If the inflation rate continues to climb, if the momentum of fixed-asset investment growth doesn't slow down, and if the asset prices rise too quickly, the central bank definitely will tighten further," said Yu Yongding, a professor and former member of central bank's monetary-policy committee.


Victoria Ruan and Rose Yu contributed to this article.

Hello! I'm relatively new to reading your blog; this is my first time commenting.

Truly, I think the higher reserve requirements raises a more fundamental question of the PBOC's defense of the yuan's de facto peg on the dollar. As long as it maintains this defense, the PBOC will have to spend billions per year on buying US treasury bills; and, of course, without a freely-floating exchange rate regime, the PBOC will never be able to conduct monetary policy and soak up excess liquidity by using its funds rate tool.

The case for allowing the yuan to appreciate is stronger than ever -- I have no doubt that reserve requirements will be raised many, many more times unless the government takes some action on this issue. It would be better to do it now while things are good than when the economy tanks and the PBOC absolutely must.
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