FocusChina in urgent need to mop up more funds to curb rising prices

09 April 2010 07:53  [Source: ICIS news]

By Pearl Bantillo

SINGAPORE (ICIS news)--China, the third largest economy in the world and Asia’s biggest petrochemical importer, may resort to more creative means of sweeping up excess funds from its financial system to keep a lid on inflation, without having to nudge up interest rates too soon, analysts said on Friday.

In a latest move towards this end, the People’s Bank of China (PBoC) issued three-year bills worth yuan (CNY) 15bn ($2.12bn) on Thursday, about three years since this monetary tool was last used.

The Chinese authorities had employed a string of non-market-oriented approach since the start of the year - including moral persuasion and issuance of stricter credit standards - to curb the rapid growth in loans that was induced by the government’s massive stimulus package last year.

Too much money floating in the financial system was causing the country’s consumer prices to spike. Inflation accelerated for the fourth straight month in February to 2.7%, with economists projecting the rate to remain at these levels for March.

China has a target to keep inflation at 3.0% this year.

"Excess liquidity is still a big issue in China," said Thomas Lam, Singapore-based group chief economist at securities brokerage DMG & Partners, adding that its economy would likely "continue to feel greater pressure on the inflation front".

“The CNY15bn bills are not big at all in size, so the move is largely a signal that the government is going to withdraw from its stimulus plan and tighten money policy,” said Ma Cheng, Shanghai-based analyst at brokerage First-Trust Fund Management Co.

But these measures and the likelihood of more to come should not be too detrimental for the country’s petrochemicals sector, said Li Hongrong, an analyst from Shenzhen-based Ping An Securities.

With about CNY10,000bn ($1,460bn) in new loans granted in 2009, Chinese companies have more than enough to go by, and petrochemical companies could still afford to build new plants, said Li.

From the macroeconomic point of view, China’s main problem has quickly turned from one of preventing a sharp slowdown in economic expansion due to the global recession in 2009, to one of potential economic heating in 2010 due to heavy liquidity injection administered last year, most analysts said.

Compounding China's problem with excess liquidity were central bank bills that would fall due this year. The country was hard-pressed to keep the level of the monetary base in check to ensure inflation does not get out of hand, analysts said.

“The central bank will continue to issue bills in the open market to control the money supply. It could also raise the reserve requirement ratio for the bank either this month or next month,” said Tommy Xie, Singapore-based economist at Oversea-Chinese Banking Corp (OCBC).

The reserve requirement refers to the portion of deposit that banks must place with the central bank which would earn a fixed yield. The ratio had been raised by 50 basis points to 16% on 18 January.

“Loan growth is still quite fast. That’s one of the reasons they [Chinese authorities] have to manage the liquidity,” said Xie of OCBC.

But China may be spreading itself too thinly doing three different tasks all at the same time given that its economic framework lacks the proper market-oriented management tool, said Lam of DMG & Partners.

“They are doing too many things at once. It’s impossible to juggle with trying to promote growth, trying to manage their currency and trying to tackle excess liquidity,” said Lam.

Tightening the noose on liquidity would inevitably lead to slower growth, he said.

“China needs to move towards the more market-oriented tools (such as) loosening the grip on its exchange rate and allowing monetary policy for domestic purposes."

Unlike most economies with free-floating currencies, China largely pegs the yuan to the US dollar. The dollar-yuan pair barely moved last year amid difficult global economic conditions.

Economists said they think China may allow a slight appreciation of its currency amid growing international pressure, particularly from the US.

US legislators were decrying that China wields an undue advantage on trade because of its weak currency, with some economists estimating that the yuan was undervalued by at least 20%.

Li of Ping An Securities said that the Chinese government does not want to raise interest rates soon because it would “give the US more excuses to push [the yuan] to appreciate.”

($1 = CNY6.83)

With additional reporting by Judith Wang and Fanny Zhang

Read John Richardson and Malini Hariharan’s blog – Asian Chemical Connections

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By: Pearl Bantillo
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