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China reserve ratio hike is mild and defensive
October 11, 2010 / 11:58 AM / 7 years ago

China reserve ratio hike is mild and defensive

BEIJING (Reuters) - China’s surprise increase of reserve requirements for its biggest banks is a response to rising capital inflows rather than a prelude to a shift in monetary policy.

It also serves as a warning to domestic banks to keep a firm grip on credit as more ample liquidity tempts them to shake off government-imposed restrictions and expand their loan books.

But in a sign of China’s wariness about the global outlook, the move is limited in both scope and time.

It only applies to the “big four” -- the country’s four leading state banks -- and two other major lenders, and it is a temporary measure, due to expire after two months.

LIMITED MARKET IMPACT

China’s three previous increases in banks’ required reserves hit global markets and weighed heavily on domestic share prices, but the impact will likely be more limited this time.

The temporary, restricted nature of the move shows that the People’s Bank of China (PBOC) is trying to stave off more stringent tightening.

The Australian dollar, stock prices in Hong Kong and oil futures, all of which are sensitive to Chinese demand, came under pressure after the news broke, but quickly pared their losses.

The Chinese stock market could dip on Tuesday, but it is due for a pullback anyway after rallying 8 percent in the last three trading days.

CONFRONTING CAPITAL INFLOWS

Ever worried about speculative inflows, China could be facing a perfect storm in the coming months. This reserve requirement increase helps it brace for the impact.

With wealthy economies still struggling to find their feet, investors have been flocking to fast-growing emerging markets such as China. The prospect of a renewed round of quantitative easing in the United States -- and hence dollar weakness -- could fuel more flows to the developing world.

Despite its efforts to limit capital inflows, China has all the makings of a prime destination.

Its stock markets, among the world’s worst performers this year, are finally showing signs of life. The Shanghai Composite Index is up nearly 18 percent over the past three months.

And the yuan is also an attractive play all of a sudden. After freezing it in place for two years, Beijing has let the Chinese currency gain over 2 percent since late August in the face of growing U.S. pressure for faster appreciation.

WARNING DOMESTIC BANKS

In singling out six banks for the reserve increase, some in the market believe China is also punishing lenders who have flouted government-imposed credit quotas.

Beijing set a target of 7.5 trillion yuan ($1.1 trillion) in new loans this year, down from a record surge of 9.6 trillion yuan in 2009 that helped power the economy through the global financial crisis.

Banks have been well behaved so far this year, restricting their lending, but there is talk that they may have been more profligate in September.

If so, the increase in required reserves reminds them that Beijing means business with its lending quota. Those that do not toe the line will be punished.

NO MAJOR TIGHTENING AHEAD

Despite robust domestic growth, China has steered clear of sharp tightening this year against the backdrop of a tepid global recovery. That is unlikely to change.

The fact that the central bank opted for a partial and short-lived reserve ratio hike means that it wanted to avoid hitting all lenders, let alone increasing benchmark interest rates.

Nevertheless, the reserve ratio increase does suggest that the bias in Beijing could be shifting every so slightly toward mild tightening.

After several months of keeping policy in cruise control, the central government has in the past two weeks stepped up its property tightening campaign and now raised reserve requirements.

($1=6.671 Yuan)

Reporting by Kevin Yao and Simon Rabinovitch; Editing by Neil Fullick

Our Standards:The Thomson Reuters Trust Principles.
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