China ups reserve ratio, but no clampdown seen

China on Friday directed banks to set aside larger reserves in an effort to tame inflation, but analysts reckon that fears of aggressive macro and monetary tightening — and even price controls — are overdone.

Late on Friday, China’s central bank, the People’s Bank of China, announced the year’s fifth hike in the reserve requirement ratio by 50 basis points effective November 29.

The aim is to step up liquidity management and “appropriately control” credit and loans, it said.

Analysts see this as the price for Chinese policymakers’ unwillingness to allow the yuan to appreciate against the US dollar.

“In our view, this policy response is aimed at mopping up excess liquidity in the banking sector as a result of heavy foreign exchange intervention to limit appreciation of the Chinese yuan against the US dollar,” said Nomura Securities analyst Chi Sun.

And although the move would have only minimal direct impact on inflation, Chi sees it as “further tightening bias to help contain inflation expectations.”

If balance-of-payment surplus pressures intensify further, “we do not rule out more RRR hikes this year —- although our base case is for no more until next year,” Chi said.

“We continue to expect no further interest rate hikes this year and our conviction level has risen on this following this latest RRR hike and the recent State Council announcement that price controls on certain commodities are being imposed.”

But other analysts see no compelling need for panicky responses to higher-than-expected inflation data.

“Fears of aggressive macro and monetary tightening are overdone,” says UBS analyst Wang Tao. “Inflation and growth outlook are different now from 2007-08, and policy responses will also take the weaker global growth prospect into account.”

Noting that the government’s initial responses to rising inflation mainly included supply-side measures and attempts to manage inflation expectations, Wang said she did not expect “immediate and widespread price controls”, as had been hinted at in media reports.  

The risk of “explosive inflation” is remote, given that China’s economic growth is set to slow to a sub-trend rate, and credit growth had already decelerated significantly, points out HSBC’s chief economist for Greater China Qu Hongbin. “Moreover, we believe Beijing has the experience and more than enough policy tools to combat inflation.”

Among these “policy tools” are, perhaps, more hikes in the reserve ratio, a lowering of new loan quotas, and issuance of more central bank bills. These moves, in Qu’s estimation, will be more effective than rate hikes to squeeze liquidity and inflationary pressures.

Additionally, the government could initiate supply-side measures —- such as accelerating agriculture production and selling state grain reserves, which should help rein in rising food prices.

If these measures are implemented effectively, Qu believes that Beijing will be able to peg CPI inflation at 3-4% next year.

Wang additionally reasons that the government does not view the recent pick-up in consumer price inflation as a sign of excess aggregate demand and general overheating, and that it continues to be worried about global growth prospects.

In that context, she argues, the government is unlikely to tighten macro and monetary policy aggressively.