Will Tightening in China Reverberate Around the World?

Many observers overlooked the fact that increases in bank reserve ratios in China and India, which reduce liquidity by curtailing how much banks can gear their equity (and banks are much more important financial players in those markets than in the US) plus a teeny interest rate increase in Japan set the stage for the market corrections we’ve seen over the last few weeks. So an interest rate increase in China doesn’t bode well.

We aren’t predicting an immediate reaction (the Bank of China took much stronger measures pre Feb 27, and no doubt has decided to tread with a lighter step), but the general trend towards less liquidity will take more froth out of the market, particularly on the fixed income side.

, in “Inflation Chckens Roosting In China?” gives the details:

From China Daily:

The People’s Bank of China, the central bank, raised key savings and lending interest rates from Sunday, March 18, the third time in 11 months in a bid to curb inflation and asset bubbles in the world’s fastest-growing major economy.

The one-year benchmark lending rate will be raised to 6.39 percent from 6.12 percent, and the one-year deposit rate will be increased to 2.79 percent from 2.52 percent, according to a statement on the bank’s website (www.pbc.gov.cn).

Time to start up the yuan appreciation clock? From the Wall Street Journal:

After Saturday’s credit tightening, [Goldman Sachs Group Inc. economist Hong Liang] said, she expects authorities in China to continue efforts to pull liquidity from the financial system with technical measures, possibly another interest rate increase and steady appreciation of its currency against the U.S. dollar…

The Chinese government, however, continues to suggest that we should not expect too much too fast. From the Financial Times:

China on Friday sought to reassure global currency markets that a new state investment agency set up to chase higher returns for its $1,000bn-plus in foreign exchanges reserves would not harm the value of the US dollar.

Are an unadjusted yuan, still-strict capital controls, and low inflation compatible goals? Normally one would would think not, but we shouldn’t forget this (again from the Wall Street Journal):

China only reluctantly adjusts base interest rates. Analysts say that reflects how interest rates have less impact on lending and borrowing decisions in China than they do in countries with more highly developed financial systems. Instead, to temper lending and the economy, China’s central bank more often relies on moral suasion with state-controlled banks and technical adjustments to capital requirements.

So, the answer is probably “Sure, if the government is willing to institute even tighter controls on the allocation of financial resources.” I doubt, however, that many would be inclined to advise taking that path.

Print Friendly, PDF & Email