China central bank taps on brakes as money supply surges

BEIJING (Reuters) - China’s currency reserves surged past the $2 trillion mark in June and bank lending hit a record high as the central bank showed concern that the flood of cash is pumping up asset prices and could sow the seeds of inflation.

China is not tightening monetary policy aggressively. Analysts rule out interest rate rises this year as the government and central bank agree on the political imperative to ensure a rock-solid recovery in the world’s third-largest economy.

But they said the People’s Bank of China was clearly indicating that the phase of monetary loosening was over and that it wanted bank lending, which has helped fuel a sharp rise in property and stock prices, to grow more moderately.

“China has achieved impressive results in reviving economic activities,” said Gao Shanwen, chief economist with Essence Securities. “The basic tone of the appropriately loose monetary policy is unlikely to change, but there will be fine-tuning.”

Gross domestic product figures due on Thursday are likely to show that the economy grew 7.5 percent in the second quarter from a year earlier, confirming China as the first major economy to pull out of a deep dive caused by the global credit crunch.

Yu Song and Helen Qiao, economists at Goldman Sachs, are forecasting 7.8 percent growth. Expressed at an annualized pace after smoothing out seasonal variations, that would equate to a 16 percent growth rate compared with the first quarter.

“We think a gradual policy tightening in an early stage would be a positive move, especially in light of the expected very strong GDP growth in the second quarter and rapidly dissipating deflationary pressures,” they said in a note to clients.


The central bank reported that its foreign exchange reserves leapt by $177.9 billion in the second quarter to $2.13 trillion.

China is the only country to have amassed over $2 trillion in currency reserves. Its stockpile is twice the size of Japan’s, the second-biggest holder, even though its economy is smaller.

As the PBOC buys most of the dollars entering China in order to prevent the exchange rate from appreciating, it issues yuan in exchange. This gives banks additional funds to lend on top of domestically created money.

“The double-pronged liquidity injection is raising risks of future tightening,” said Ken Peng, Citi’s economist in Beijing.

The broad M2 measure of money supply grew at a record pace of 28.5 percent in June, blowing past forecasts of a 26 percent rise and up from a 25.7 percent increase in May.

Yuan loans outstanding were 34.4 percent higher than a year earlier, also the highest on record, up from May’s reading of 30.6 percent.

Soon after the PBOC announced the credit data, traders said it informed a clutch of banks that they would be required to buy 100 billion yuan ($15 billion) in special bills in September -- money that they could otherwise have loaned out.

The sum is tiny, but it follows other warning shots in recent weeks. The central bank has resumed one-year bill sales and has nudged up yields in the money market.

“Everybody -- the regulators and the banks -- knows that the lending spree can’t go on like this,” said He Weijiang, an analyst with Central China Securities in Shanghai.


Economists said the central bank will be particularly concerned by evidence that speculative capital, or “hot money,” is flowing back into China again.

The $177.9 billion build-up of reserves in the second quarter far exceeded the combined proceeds of China’s trade surplus and foreign direct investment inflows. FDI fell for the ninth month in a row in June, the Ministry of Commerce said on Wednesday.

In the first quarter, by contrast, reserves rose just $7.7 billion, as the global credit crisis caused banks to call in loans and multinational firms to repatriate profits.

Changes in reserves are clouded by a host of undisclosed transactions and swings in the valuation of non-dollar assets, but Stephen Green with Standard Chartered Bank in Shanghai said he could not explain $30 billion of the rise in reserves.

China deploys capital controls, which means investors cannot buy or sell the yuan freely for non-trade purposes. But foreigners -- and Chinese investors -- have myriad ways to evade the controls and bring money into the country if they want to buy property or shares or simply bet on the yuan heading higher.

The property market has strengthened dramatically in recent months, while the Shanghai stock market is the best performing major bourse in the world. The main index .SSEC gained 1.38 percent on Wednesday on the heaviest turnover in two years, leaving it up 75 percent so far this year.

“Hot money, for want of a better name, may be back, encouraged by super-loose credit and numerous signs of bubbles forming,” Green said in a note to clients.

($1=6.832 Yuan)

Writing by Alan Wheatley; Editing by Tomasz Janowski