Riding on the dragon back of loans is dangerous: Wei Gu

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

By Wei Gu

HONG KONG (Reuters) - Is it 600 billion yuan, is it 1 trillion yuan? No, it's a massive 1.53 trillion yuan ($224 billion) for June new loans in China!

The number is so unexpectedly large -- more than doubling the May level -- that the central bank decided to release it a few days earlier than planned to send a clear message that China's slack monetary policy is getting too loose and it is time to worry about asset price bubbles.

Half an hour before it dropped that bombshell, the People's Bank of China also started to resume sales of one-year bills, after a seven-month hiatus, to help mop up liquidity from the system. But the auction size of 50 billion yuan is tiny compared with the flood of new loans entering into the system. New bank lending in the first half of this year is up 200 percent from the same period last year. Total credit for the period equals a quarter of last year's gross domestic product.

Initially, investors sold off banking and property stocks in anticipation of further tightening to come, but those stocks quickly recovered, reflecting the belief that Beijing will at most fine-tune its loose monetary policy, rather than reverse it.

This logic follows the recent meeting between Chinese Premier Wen Jiabao and his economic advisers which decided to keep monetary policy slack. Beijing is determined to keep the economy growing fast, judging that the inflationary risk is outweighed by the need to ensure stability and protect jobs.

The civil unrest in the far west may have reinforced this view, but if inflationary expectations become embedded, there is a risk of inflicting more damage to the real economy.

Money flocking to stocks and properties risks crowding out investment into the real economy. There is plenty of anecdotal evidence that companies have been borrowing money for projects, but are instead putting it into stocks or property for a quick profit. The winning bidders in some recent land auctions have been cash-rich companies from non-real estate sectors, because it is harder for property companies to obtain loans, while property prices in Beijing, Shanghai and Shenzhen have risen 20 percent since April.

Such asset price inflation, allied to low consumer price inflation, has been a lead indicator of trouble in western economies, but China's faces tough policy decisions. Hiking rates might not be the most effective way to curb lending. Administrative measures such as ordering banks to stop lending, higher property taxes and down-payment requirements, and most importantly, slowing approvals of new projects related to the stimulus package, may be more appropriate.

Beijing cannot afford to wait for too long, otherwise it will have to hit the brake much harder and the inevitable slowdown will be more painful -- something Beijing wants to avoid during a year full of sensitive anniversaries.

-- At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. --

(Editing by Martin Langfield)