China’s central bank has shown signs of inching toward a tighter monetary policy this week, pressed by rising inflation, runaway house prices and renewed capital inflows. That’s on top of the long-term job of getting mounting debt under control before it overwhelms the economy.
Restricting lending fits authorities’ goal to move the economy toward consumption-led growth rather than an investment-driven model. But the People’s Bank of China must walk a tightrope: Moving too aggressively could aggravate strains on the financial sector, already shaken by a severe cash crunch earlier this year.
The PBOC has plenty of reasons to turn more hawkish. Consumer price inflation ticked up to 3.1% in September, still well within the official 3.5% target but the second-highest figure in a year. House prices are on a more alarming trajectory, climbing 8.2% on average in the year to September, and even faster in the largest cities.
The U.S. Federal Reserve’s decision last month to keep its economic stimulus in place for now has prompted a renewed movement of capital into China. The PBOC and other Chinese financial institutions bought a net 126.4 billion yuan ($20.7 billion) of foreign currency last month as money flowed into the country.
The PBOC needs to suck cash out of the system to keep it from feeding inflationary pressures.
At least a reviving economy means China is better placed to withstand tightening than it was earlier in the year: GDP growth bounced back to 7.8% on-year in the third quarter, from 7.5% in the second.
With growth on its side, the central bank drained 58 billion yuan ($9.54 billion) from the interbank market this week. The seven-day reverse repo rate, a benchmark indicator of liquidity conditions, climbed to 4.79% on Friday from 3.49% a week earlier, showing that banks are having to pay more for their funding.
Traders said liquidity began to loosen again Friday afternoon, probably because of central bank intervention. The PBOC is likely wary of overshooting: The last time it withheld liquidity, in June, the fragile interbank market all but froze up.
Some economists detect a bigger agenda, saying the central bank may be moving to stop lending – both within and outside the traditional banking system – from spiraling out of control.
In June, the PBOC made a concerted effort to stop borrowers using the interbank market to fund speculative “shadow banking” activities. With the central bank’s liquidity support withdrawn, interest rates quickly went through the roof.
After stock markets tumbled and panic began to take hold, the central bank turned the taps back on, but the message had been sent.
Since PBOC Gov. Zhou Xiaochuan “started his new term in March he’s been trying to do this,” said Ken Peng, an economist at BNP Paribas. “The looser policy between July and September was a pause in a longer effort to try to rein in growth of the money supply.”
China’s debt has been growing at a stupendous pace. Total social financing, the broadest official measure of credit creation – which includes shadow banking and bond issuance in addition to bank loans – declined to 808.8 billion yuan in July amid the tighter conditions, the first time in more than a year that the monthly figure failed to top one trillion yuan. But it quickly bounced back to 1.57 trillion yuan in August and 1.4 trillion in September.
Outstanding borrowing by businesses and households hit 170% of gross domestic product at the end of 2012, up from 117% in 2008, according to the Bank for International Settlements. It’s the speed of the climb, as much as the total, that worries economists.
With sustained growth and moves toward reform, some have faith that the explosion of debt can be kept under control.
“We know there are leverage issues in the system, but the current pace of credit creation is not as rapid as in the past,” said Li Wei, an economist at Standard Chartered. “The PBOC clearly wants to slow the pace of credit growth, and policies are moving in the right direction.”
But pessimists note that credit growth has run far head of the real economy, which has needed ever bigger hits of funding to get short-lived bursts of growth. That puts regulators in a bind.
“It’s going to be difficult to tighten in an aggressive way because the economy has become so reliant on credit,” said Charlene Chu, an analyst at Fitch who is deeply skeptical about China’s ability to get its debt load under control. “To rein in credit significantly without that itself slowing growth is going to be very difficult.”
The PBOC may want to cut down the dosage, but China won’t be deleveraging cold turkey any time soon.
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