Analysis:China PBOC Hikes Reserves To Take Control Of Lending

BEIJING (MNI) - The People's Bank of China announced Friday the second reserve hike of the year as the government steps up its controls on the banking system in a bid to bring a degree of order to lending activity.
 
Some in the market had been expecting a central bank announcement today, the eve of the week-long Chinese Lunar New Year holiday.
China's capital markets will be closed until February 22 as part of in which the PBOC traditionally ensures that the banking system is stuffed with liquidity to meet increased cash demands from depositors.

The bank injected a net CNY508 billion into the banking system over the last two weeks and few in the interbank system expected the PBOC to allow it to linger there for long after the holiday.
The reserve hike, which will take effect Feb. 25, will lock up an estimated CNY350 billion in liquidity, said Lu Zhengwei, chief economist of the Industrial Bank in Shanghai.
The central bank announced the first reserve hike of the year on January 11 to take effect January 18, the first increase since June 2008.

The timing of that move was a surprise; most had been expecting a move later in the quarter, and only after interbank market rates had been guided up sufficiently.

But the next increase in the reserve requirement was always a case of when, not if.
As well as the liquidity that has been added to the system ahead of the holidays, nearly CNY800 billion in outstanding PBOC paper is due to mature in February and March, according to estimates from China International Capital Corp, a mainland investment banking joint venture.

The PBOC's increasingly aggressive liquidity management seen this year stems from the government's seeming inability to control the banking system. Chinese banks extended CNY1.39 trillion in new loans during January, eclipsing the lending total for the fourth quarter and not far off January 2009's CNY1.62 trillion.

But 2010 is not 2009 and the government is no longer in crisis-mode. Significant though the January lending tally was, it was pared back significantly during the month after the government implemented a series of Draconian measures to bring the banking system to heel.

The government's tightening intentions were brought forward after reports that banks lent out CNY600 billion during the first week of January alone.

By the end of the second week, banks had lent out well over CNY1 trillion, according to industry sources, prompting a move to shut down lending operations in many bank branches around the country. And some banks were forced to cancel agreed loan contracts, according to reports.

The PBOC is expected to continue raising the reserve requirement and expanding the size of its open market operations to bring down liquidity levels and bring the banking system into line. (The reserve ratio will stand at 16.5% for large banks after the latest adjustment, not far from its recent historical peak of 17.5% reached in summer 2008.)

Still, the government has continued to signal that it will only gradually tighten monetary policy this year.
Interest rate hike forecasts for the current quarter took a knock on Thursday when the government said that consumer price inflation rose only 1.5% y/y in January, down from December's 1.9% growth and far below market estimates at over 2%.

Although the economy grew by a hefty 10.7% y/y in the fourth quarter of last year, and is again expected to grow well above 8% in 2010. But analysts continue to warn that the recovery is highly uneven, with asset prices the most obvious beneficiaries of the massive infusion of cash and credit into the economy.

A slower approach to tightening overall monetary policy doesn't let the banking system off the hook. Bank regulators have indicated that they are targeting CNY7.5 trillion in new loans this year versus 2009's record CNY9.6 trillion.

The government had to step in after preliminary reports suggested that January alone could have seen over a third of the annual target eaten up.

Many of China's bank employees have already left the big cities for their hometowns to celebrate the incoming year of the Tiger and have a rest.

And well they might, because the government has signalled that it isn't willing to tolerate another record year for credit creation, meaing that 2010 is going to be noticeably more difficult for them.