http://online.wsj.com/public/article/SB115046775124382390-imldtklZudouSeYYwlES47fsj3c_20060623.html?mod=regionallinks
SHANGHAI -- China's latest credit tightening could push the country's
financial markets lower in a critical week that will see domestic pricing of a
stock offer by Bank of China Ltd., the biggest ever initial public offering in
mainland China. Less clear is whether it will have the intended effect: curbing
Chinese bank lending to damp torrid economic growth and head off any resulting
inflationary pressures.
The move, the second since April aimed at slowing the world's largest and
fastest-growing developing economy, sent ripples of concern Friday through
international markets, causing the dollar to strengthen briefly. A slowing of
the economy could soften commodity prices and crimp some multinationals' sales
in China. In China, it could dent a stock market that is off its high for 2006,
though the benchmark Shanghai Composite Index is still up 36% so far this year.
China's central bank, the People's Bank of China, said late Friday it will
lift its reserve-requirement ratio for commercial banks, effective early next
month, by a half percentage point to 8%. The reserve requirement targets the
amount of deposits that banks must set aside instead of lend; a bank holding
deposits of the equivalent of $100 would have to set aside $8 in reserves, thus
limiting the amount it can lend.
"It's just freezing the liquidity," said Jonathan Anderson, UBS AG's chief
regional economist in Hong Kong. "The real impact is to get banks to start
slowing" their lending.
Still, analysts expect prices of Chinese stocks and bonds to fall initially
as banks adjust their balance sheets to comply with the change. "The A shares
will drop a little [today] but will soon resume their increases," said Hu
Weidong, an analyst at Xiangcai Securities Co. in Shanghai, who worries more
about rising interest rates in the bond market.
A heavy drain of financial-system liquidity could cool demand for shares in
Bank of China being priced and offered for Chinese investors this week, though
analysts still anticipate strong interest for the Beijing bank's stock.
Bank of China is expected to set the pricing Thursday for its offer of as
much as $2.5 billion in Class A shares for the Shanghai market. The offer will
supplement this month's $11.2 billion IPO in Hong Kong.
Tighter credit coupled with recent gains in the yuan and new rules on
property speculation reflect how China's leaders are increasingly concerned that
a surge of loans is prompting excessive investment, which in turn could spill
over to higher prices. A raft of financial data during the past week pointed to
quickening growth and possible inflation, despite an increase in lending rates
in April.
For instance, the central bank said its key money-supply measure expanded 19%
in May from a year earlier, while lending in yuan increased 16% in May. The
rates were some of the highest in two years. China's economy grew at a rate of
10.3% in the first quarter.
With increased lending, investment levels are surging. Fixed-asset investment
jumped 30% during the first five months of this year, the government reported
last week. As investment in new factories and property rises, so do risks the
projects will incur losses and bank loans will go bad.
Banks provide almost all of the financing in China's economy, and China's top
leaders openly called on them to slow lending after the past week's economic
data. "The fast growth in the fixed-asset investment should be firmly curbed,"
Premier Wen Jiabao said last week.
Authorities are particularly concerned with overinvestment in risky
industries such as property. Manufacturing is another worry, as increasing
numbers of factories are driving up China's costs of importing energy and raw
materials.
China's surprise April increase in lending rates was the first boost since
late 2004, and the move -- the benchmark one-year-loan rate rose 0.27 percentage
point to 5.58% -- signaled to economists that the government will address fast
growth with market-oriented measures. However, the May data reported in the past
week strongly suggested the higher interest costs had little impact in
curtailing borrower demand for loans.
In contrast, the reserve requirement takes cash out of the system at its
source -- the banks -- and it has traditionally had a stronger effect on bank
behavior than other credit-tightening moves. It was raised most recently in
April 2004 and September 2003. The central bank says the latest increase will
remove the equivalent of $18.75 billion from the banking system but won't take
effect until July 5, a time gap that likely reflects the jostling that banks
need to do to adhere to the policy.
The instrument is "blunt," but "its effectiveness tends to be eroded very
quickly," Goldman Sachs economist Hong Liang said in a report. Yu Kai, an
analyst at Newland Securities Co. in Wuhan, said the stock market "has been
talking on it since this May, and the market performance has already reflected
these expectations."
Today, Chinese banks could sell domestic bonds to raise cash, which also
would signal higher interest rates in the country's debt markets. China's market
interest rates already have been creeping up this year, partly in anticipation
of more tightening, with one-year central-bank bills fetching as much as 2.48%
last week, compared with 1.9% at the beginning of 2006.
Banks in China lend so freely because of their large deposit base, and
figures suggest most are well able to adhere to the new reserve requirement. On
average at the end of March, China's banks had placed 10.5% of total customer
deposits of nearly $4 trillion at the central bank, above the new regulatory
minimum reserve requirement of 8%. But weaker banks believed to be doing the
most speculative lending might be more severely affected, partly because higher
reserve ratios apply to them. In addition, banks have far lower excess reserves
on average than they did before the 2003 ratio increase was announced -- a move
that briefly sent overnight interest rates above 15% in China as banks scrambled
to raise cash by selling bonds.
U.S. stocks initially fell Friday as investors worried that China's move to
slow lending could affect corporate earnings. The Dow Jones Industrial Average
edged down 0.64 point to 11014.55.
Mr. Anderson of UBS said investors shouldn't be concerned that Chinese
authorities are trying to slow the economy so much as they are braking its
recent "accelerationist" tendencies. He said an increase in reserves was
expected.
China also has been taking less-market-oriented steps to cool the economy, in
particular by adjusting rules in ways designed to make property speculation less
appealing.
Meanwhile, China has been permitting the yuan to rise more quickly in recent
days, another possible effort to tighten credit in the financial system.
In Shanghai currency trading late Friday, the U.S. dollar was at 7.9992 yuan,
after trading in a range of 7.9970 yuan and 8.0007 yuan. While not significant
in the context of global currency-exchange movements, the level of eight yuan to
the dollar is a psychologically important point that the currency market tested
in three of five sessions last week.
As the yuan rises, it makes China's exports more expensive in U.S. dollar
terms. The U.S. administration has argued that a stronger yuan helps reduce
China's trade surplus.
Citigroup Inc. economist Yiping Huang said a rising yuan will be used along
with higher interest rates and other measures to cool China's economy.
"Accelerated appreciation of the [yuan] now looks inevitable," he said in a note
Friday.
