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　　HOUSING SQUEEZE: Some experts think a tighter money supply will have the most impact on the real estate sector
　　
　　From August 15, the required reserve ratio of state-owned and joint-stock commercial banks with the central bank will be further increased by 0.5 percentage points to 8.5 percent, the People’s Bank of China (PBC) announced on July 18. This is the second time the central bank will raise the ratio in 40 days, managing to curb banking lending.
　　State-owned and joint-stock commercial banks currently have to hold 8 percent of customer deposits and notes as reserves, effective as of July 5, which is itself 0.5 percentage points higher than before.
　　The back-to-back increases indicate the central bank’s worry about excess money in circulation, financial experts argued.
　　China managed to tighten up its money supply shortly after the economy was reported to rocket 10.3 percent in the first quarter.
　　On April 28, the PBC raised the one-year benchmark loan rate by 0.27 percentage points, from 5.58 percent to 5.85 percent. In mid-May, the central bank issued one-year bills worth 100 billion yuan to primary underwriters in the inter-bank market. On June 13, the same amount of bills were issued again.
　　
　　Concern over overheating
　　
　　The PBC said in a statement its further upward revision of the required reserve ratio on August 15 is motivated by the rapid growth of fixed assets investment, large volume of money supply and credit and a large trade surplus.
　　According to preliminary estimation of the National Bureau of Statistics, China’s gross domestic product in the first six months of this year totaled 9.14 trillion yuan, a year-on-year increase of 10.9 percent. The growth for the second quarter alone was 11.3 percent. By the end of June, fixed assets investment throughout the country amounted to 4.24 trillion yuan, surging 29.8 percent compared with the year-earlier period. China’s trade surplus stood at $61.4 billion.
　　The PBC’s financial report of May also shows that broad money M2 (money in public circulation comprising banknotes, coins, and call deposits, i.e., narrow money M1, plus business and household time and savings deposits in the commercial banking system) reached 31.67 trillion yuan at the end of May, rising 19.1 percent over a year ago. Renminbi loans of financial institutions increased by 1.78 trillion yuan from January to May, 793.9 billion yuan more than the same period last year.
　　The monetary policy goal for this year set by the PBC in January is that broad money M2 will grow 16 percent and new renminbi loans by domestic financial institutions will total 2.5 trillion yuan. However, growth of M2 in the first five months has already surpassed the preset mark and new loans in the period accounted for more than 70 percent of the year’s target.
　　The reserve ratio increase is aimed at restraining the rapid growth in lending and maintaining a stable monetary and financial environment for the sustained and healthy development of the national economy, according to the PBC statement on July 18.
　　
　　“The rapid increase in credit may overheat the economy and lead to inflation. So it is necessary to step up regulatory measures,” said Li Chao, the central bank’s spokesman.
　　Since three years ago, the Chinese Government has been consciously holding down runaway fixed assets investment, to avoid an overheated economy. The surge in fixed assets investment did settle down but potential expansion remained strong. The threat of a rebound in investment existed all through 2005 and into 2006. It is estimated that a fixed assets investment growth of more than 30 percent this year may lead to GDP growth of more than 10 percent, much higher than the 8 percent goal set by the government.
　　The rapid growth in fixed assets investment is attributed mainly to excessive growth in lending by China’s financial institutions. Most economists believe this is what is behind the nearly 30 percent growth of fixed assets investment in the first half.
　　“The central bank’s clampdown on money supply is necessary for the current economic situation,” said Hai Wen, Deputy Director of the China Center for Economic Research at Peking University.
　　
　　On target?
　　
　　OUT OF SIGHT: China’s central bank hopes to mop up 150 billion yuan from circulation through a 0.5-percentage-point increase in the required reserve ratio for lenders
　　The increases in the required reserve ratio will have little impact on commercial banks, Li predicted.
　　According to him, the outstanding balance of both required reserves and excess reserves of commercial banks at the PBC has topped 2.3 trillion yuan, and commercial banks hold more than 7 trillion yuan of high liquidity assets including treasury bonds, financial debentures and central bank bills. Though a 0.5-percentage-point increase in the required reserve ratio will immediately freeze 150 billion yuan of liquidity, commercial banks will have enough time to adjust their liquidities to adapt to the new reserve requirement. Also, the central bank has pledged to relax its open market operations after the increases in the required reserve ratio to facilitate financial institutions to adjust their assets and liability structures.
　　Commercial banks will still have plenty of usable funds to maintain their normal payment and settlement and be able to increase loans steadily, Li added.
　　“The increases in the required reserve ratio can turn excessive money supply into a moderate one,” said Xia Bin, Director General of the Financial Research Institute under the Development Research Center of the State Council. “But they are not an overall tightening of money supply. Commercial banks won’t be affected significantly.”
　　The real estate industry will be affected the most, according to Li Daokui, Director of the Center for China in the World Economy at the School of Economics and Management of Tsinghua University, who pointed out that increases in the lending rate and the required reserve ratio in recent months are both aimed at slowing down the growth of bank loans.
　　
　　“Property developers depend heavily on bank loans. A major objective of the central bank’s tightening measures is to cut down loans to the real estate industry,” Li explained.
　　Andy Xie Guozhong, Chief Economist of Morgan Stanley Asia Pacific, agreed that reduction of money supply would have a significant impact on capital-intensive industries such as real estate, automobile and iron and steel.
　　In his opinion, the removal of 150 billion yuan from circulation may not greatly affect the liquidity of the banking system, but loan opportunities for businesses will decrease. With the central bank continuing to tighten money supply, he said, enterprises will be hard pressed for large sums of capital for developing new projects and will naturally reduce investment.
　　Meanwhile, Xie pointed out that the cost of financing through channels other than banks would also increase. As a result, Xie said, the real estate industry will be forced to shrink the scale of investment. He predicted some real estate developers might be anxious to undersell houses on hand to get back money because of shortage of capital sources.
　　Zhong Wei, Director of the Financial Research Center of the Beijing Normal University, however, contended a higher required reserve ratio would not radically change the growing momentum of loans, although it could affect the expansion of financing by enterprises to some extent.
　　According to the professor, the growing momentum of bank loans did not slow down after the central bank raised the lending rate and issued colossal amount of bills, as new loans of financial institutions in the first five months had already accounted for 70 percent of the annual quota and maintained a rapid growth in June.
　　“Under these circumstances, the central bank had to raise the required reserve ratio consecutively,” Zhong said. “The increase of 0.5 percentage points, however, seems too mild.”
　　Chinese banks have abundant surplus money. Household saving deposits have outstripped 14 trillion yuan, and continue to grow rapidly. This, plus the mounting foreign exchange reserves, provides guaranteed credit capital to commercial banks. Even though 150 billion yuan is frozen, they have enough money to loan, Zhong noted.
　　Banks are profit-oriented financial enterprises. Placing more emphasis on whether the loans will generate profits, Zhong said they will not cut back lending because of the central bank’s symbolic tightening of credit.
　　
　　Interest rates
　　
　　Ma Jun, Deutsche Bank’s Chief Economist for Greater China, said that in the next three-four months, China might further raise the interest rate or the required reserve ratio.
　　Since money in circulation is growing rapidly, increasing the required reserve ratio by 0.5 percentage points can only slow down its growth, as well as that for loans, by up to 1 percentage point. Although the central bank issued large sums of bills in May and June, the amount of additional bills is limited, as many old expiring bills have to be bought back. In other words, merely depending on issuing these bills can far from solve the problem of excess liquidity. The central bank should take other stronger measures more frequently.
　　
　　However, many other economists think that China will not substantially tighten money supply, saying China had maintained a prudent monetary policy for the past two years and a change was unlikely in this year. Moreover, they emphasized that China’s decision makers would not cool down the economy by substantially tightening money supply for fear that problems may crop up in economic development and employment.
　　A sharp slowdown in economic growth is believed to undermine the efforts to create 9 million new jobs annually proposed by Premier Wen Jiabao. To check the unemployment rate from climbing, stable economic development will have to be maintained.
　　PBC Governor Zhou Xiaochuan said at a meeting in June that another increase in the interest rate was not on the agenda.
　　But a PBC official asking to remain anonymous said that, with regard to monetary policy, more bills might be issued to targeted banks.
　　“All banks, big or small, are equal in the eyes of the credit-tightening policy, but it is unfair to use a single policy in that a higher required reserve ratio would dampen banks that have always been conforming to the central bank’s policies,” the official said. “This can be avoided by issuing bills. Furthermore, issuing bills can be regularized. After examining monthly financial data, the central bank can decide whether or not to use them.”
　　In fact, all designated buyers of the central bank bills in the June 13 issuance were lenders whose new loans were growing too fast, including the China Construction Bank, the Agricultural Bank of China, the Industrial and Commercial Bank of China, the Bank of Communications, the China Everbright Bank, the Shanghai Pudong Development Bank and the Shenzhen Development Bank.
　　From January to May, new loans granted by the China Construction Bank arrived at 326.5 billion yuan, or 18.34 percent of the national total. So the bank had to buy the most bills worth 42 billion yuan. The second was the Agricultural Bank of China, buying 30 billion yuan; the Industrial and Commercial Bank of China, 12 billion yuan; the Bank of Communications, 10 billion yuan; the China Everbright Bank, 3 billion; the Shanghai Pudong Development Bank, 2 billion and the Shenzhen Development Bank, 1 billion. The rate of return on these bills is only 2.11 percent, much lower than in the secondary market, clearly indicating central bank’s intention of punishment.
　　The Bank of China and the China Merchants Bank targeted by the previous issuance showed their prudence in granting loans in May. So they were exempted from the list of targeted banks in the June issuance.
　　The PBC official also said, through issuing bills, the central bank hopes to force the targeted banks to exercise more prudence in granting loans, while warning others of the severity of the monetary policy.
　　But economists are skeptical of the effectiveness of the central bank bill issuance.
　　Hai Wen from Peking University proposed whether or not China would take further tightening measures depended on future economic data. “If the economy continued to overheat, raising the interest rate or other measures would probably be taken,” he said.

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