Anything but rate hike policy in China | FT Alphaville

Anything but rate hike policy in China

Remember how every man and his dog were speculating about an imminent interest rate hike in China?

Well it seems most analysts have now changed their tune.

From Bloomberg on Monday:

China’s benchmark interest-rate swaps fell for the third day on speculation policy makers will refrain from raising interest rates before year-end. Bonds rose.

Banks’ reserve requirements and central bank bill sales may be better tools for controlling inflation than interest rates because higher rates may attract capital inflows and pressure repayment of local borrowings, reported the People’s Daily today, citing Ba Shusong, a researcher for the nation’s cabinet.

The amount of cash lenders must set aside as reserves will rise by 50 basis points from today, the sixth increase this year.

“We don’t see a further interest-rate hike by the end of the year as the central bank already increased the reserve requirement ratio,” said Emmanuel Ng, a strategist in Singapore at Oversea-Chinese Banking Corp. “Bill auctions, where yields haven’t been that aggressive, show there’s no rush to raise interest rates.”

Market consensus is now increasingly suggesting that China will restrict itself to quantitative tightening rather than deploy any outright interest rate hikes to cool inflation. And, if rate rises were to come, they would only be very gradually implemented .

It’s something we’ve called ‘anything but rate hike policy‘.

Amongst those who have always said as much are economists at Capital Economics. Why? Because: a) Beijing wasn’t as concerned about inflation as it was about attracting hot capital inflows (à la the Japan experience) and b) rate hikes were hardly ever going to be that effective in China anyway. Indeed, their prediction was for a 25 bp rate hike, at most, over the next 12 months.

In their latest piece, the economists continue the theme:

Markets have scaled back their expectations for policy tightening in China as senior officials have made clear that they see no need for a major policy shift. The government’s stance is based in part on the view that inflation will soon level out. But policymakers also seem to fear that rapid tightening would threaten what they view as a fragile economic situation.

Monetary policy is now officially termed “stable” and the 2011 credit quota looks likely to be far less restrictive than previously anticipated (probably over RMB7trn). Given the sanguine view on inflation and fears about hot inflows, interest rate hikes seem likely to come through slowly. Similarly, the pace of renminbi appreciation will probably remain slow. This means that monetary conditions will be supportive for financial markets. But, as long as the inflation and policy outlook is uncertain, volatility is set to continue.

The problem with rate hikes, of course, is that since net savings account for a much bigger slice of the market in China than loans it is feared higher interest rates could have the precise opposite of the intended effect. If anything, they may make depositors feel wealthier, encouraging more spending throughout the economy.

China’s top priority, consequently, seems to be encouraging moderate loan growth — or, rather, developing a market structure which would make rate hikes far more effective if and when they are finally deployed in size.

As Capital Economics notes, it is already understood that China’s state-controlled bank loan quota is likely to be breached this year:

Banks continued to extend large volumes of loans in November (5) and are set to breach the RMB7.5trn annual quota in December. The quota for 2011 has not yet been confirmed, but it is rumoured to be

RMB7trn or higher, which would be relatively loose. Growth of demand deposits, a measure of firms’ short-term spending intentions, appears to have bottomed out. Harder-to-access time deposits are still growing faster (6). This goes some way to explain why rapid lending growth since 2008 has not driven a similar increase in nominal activity.

On Tuesday, China’s banking regulator stepped things up even further. While on the one hand it tightened rules governing bank transfer disclosure — because such transfers are used by banks to get round official loan quotas since they don’t currently show up in their books — on the other hand specualtion mounted that the PBOC would dissolve the quota system altogether.

As Reuters reported:

The People’s Bank of China (PBOC) may drop the overall loan quota system and decide how much a bank can lend by looking at lenders’ capital adequacy ratios, liquidity conditions and provisions for bad loans.

In other words, it may represent a move towards a more westernised banking structure in which such things as interest rate hikes really do begin to make sense.

It’s also further evidence, we would say, of the huge balancing act that lies ahead for China if it is to control its economy effectively in the months and years to come.

But, overall, moderately goes it for now.

Related links:
Dim sum bonds are the new euroyen bonds
– FT Alphaville
A cash crunch in China
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Here comes the quantitative tightening…
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China’s non-appearing rate-hike – FT Alphaville