China Reluctance on Reserve Cut Signals Inflation Concern
China’s slower-than-forecast cuts in banks’ reserve requirements show authorities are reluctant to shake their concern inflation will quicken, three months after Premier Wen Jiabao shifted priorities to boosting growth.
China has left the reserve ratio for the biggest banks at 20 percent since mid-May while lowering interest rates in June and July, bucking forecasts from HSBC Holdings Plc and Societe Generale SA that the government would build on three ratio reductions since Nov. 30. Industrial-production and loan data for July that missed estimates last week fueled further speculation the People’s Bank of China would cut the ratio as soon as Aug. 10.
The hesitation risks increasing the odds that growth will decelerate for a seventh quarter just as Communist Party leaders gather for a once-a-decade power handover. The PBOC said this month that price gains may rebound after August and a newspaper published by the institution said more reserve-ratio cuts would backfire by increasing inflation expectations.
“The central bank is still concerned about a rebound in inflation, and it is reluctant to loosen too much on the liquidity side,” said Xu Gao, an economist with Everbright Securities Co. in Beijing who previously worked for the World Bank. “The key problem now is that banks have money but the money can’t be channeled to the real economy.”
China has kept its reserve ratio proportionately tighter than interest rates. The ratio is 7 percent below the record 21.5 percent, while the one-year lending rate is a fifth lower than its peak in the past decade of 7.47 percent in 2008. That’s before even considering that the PBOC last month allowed banks to offer discounts of as much as 30 percent from benchmark rates.
Economists had forecast in March that the ratio would drop to 19.5 percent by June 30 for the largest banks, based on the median estimate in a Bloomberg News survey.
“The most significant economic event of 2012 just failed to occur,” Glenn Maguire, principal at consultant Asia Sentry Advisory Pty Ltd. in North Sydney, Australia, and former Societe Generale chief Asia economist, said in a research note today. “The end result of newfound policy prudence may be a more sustainable medium-term outlook.”
China’s consumer prices rose 1.8 percent in July from a year earlier, below the government’s target of 4 percent for the year. Producer prices fell 2.9 percent. At the same time, the worst U.S. drought in 56 years has sent soybean and corn prices soaring, risking higher costs for pork, a staple meat in the Asian nation.
The PBOC has stepped up the use of another tool to pump temporary funds into the financial system. The central bank has injected 826 billion yuan ($130 billion) since late June by offering seven- and 14-day reverse-repo contracts, according to data compiled by Bloomberg. The previous reserve-ratio cut of 50 basis points probably released 450 billion yuan into the financial system, according to Goldman Sachs Group Inc.
The actions have failed to produce a sustained increase in credit. New local-currency loans tumbled 41 percent last month to 540.1 billion yuan, the lowest since September, missing all 30 estimates in a Bloomberg News survey.
China’s seven-day repo rate, a money-market benchmark, has increased over the past week from 2.65 percent on Aug. 7. The rate rose 8 basis points to 3.43 percent at 1:33 p.m. in Shanghai today. The yuan has weakened about 1 percent against the dollar this year.
Separately today, Chinese banks’ bad loans increased for a third straight quarter for the first time in eight years, a report from the China Banking Regulatory Commission showed. Bad loans surged at all types of banking institutions, including the largest state-owned lenders, rural banks and foreign banks, the regulator said.
Barclays Plc, Deutsche Bank AG and Bank of America Corp. cut their forecasts for third-quarter growth, while Morgan Stanley lowered its outlook to 8 percent expansion for 2012, down from 8.5 percent.
“The central bank is trying to calm down market sentiment a little bit as the two interest-rate cuts have in fact generated some panic about China’s economy,” said Liu Dongliang, an analyst with China Merchants Bank in Shenzhen. “Also, a lower required-reserve ratio may fail to boost bank loans when banks are very cautious about lending.”
China is preparing for its 18th Communist Party Congress, with officials widening efforts to bolster the legitimacy of a leadership transition clouded by the ouster of Politburo member Bo Xilai. Of the 2,270 delegates elected to attend the meeting, 521 are women, 76 more than in 2007, Wang Jingqing, a vice minister of the Organization Department, said at a briefing yesterday in Beijing.
Wang didn’t give a date for the party congress. The six meetings since 1982 have all been held between September and November.
Past monetary actions aren’t necessarily a guide to future ones, and China adjusts reserve ratios and interest rates without warning or adhering to a meeting schedule as other central banks do.
The government’s stimulus actions have also included accelerated approvals of investment projects, while cities including Changsha are pursuing billions of yuan of infrastructure building that may give the economy a boost. At the same time, officials are signaling they will maintain property controls to curb home-price gains.
“China’s policy has already been loosened quite a lot in June and in July,” Zhang Zhiwei, the chief China economist for Nomura Holdings Inc. in Hong Kong, said on a conference call with reporters yesterday. The effects of reverse repos in providing money for the banking system can be similar to reserve-ratio cuts and the tool is more flexible, Zhang said.
Authorities haven’t lowered the reserve ratio since May “probably because of uncertainty on capital flows,” Zhang said in a separate interview. Government figures this month showed a $71.4 billion capital-account gap last quarter, the widest in quarterly data going back to 1998. Zhang said in a note last week that the July loan figures were “offset by very strong bond issuance.”
Even so, the central bank is still likely to cut the ratio in the next one or two months, Zhang said.
Injecting temporary funds into the market can’t replace reserve-ratio cuts in the long run, said E Yongjian, a Shanghai- based economist with Bank of Communications Co., the country’s fifth-largest lender by assets.
“The delay in cutting the reserve-requirement ratio can push up money costs and weaken policy-loosening effects,” E said. “To encourage bank lending, cutting the RRR is not a sufficient condition but a necessary one.”
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