Yi Xianrong
The People's Bank of China, the central bank, announced on
January 5 that it would raise the required reserve ratio for
financial institutes engaging in deposit business by 0.5 percentage
points from January 15.
It is the fourth increase of the deposit reserve ratio since
July 2006 in an attempt to reduce excessive liquidity and ease the
pressure of a boom in bank loans.
This move consolidates the accomplishments of the past year's
macroeconomic controls.
The central bank has taken a series of measures to cut down
excessive liquidity, which include increasing deposit reserve ratio
and increasing interest rates. But nothing seems to have worked and
the redundant liquidity is still a major headache for China's
financial market.
If decision-makers cannot pin down the core of the problem, any
policy tools implemented may only have limited effects on tackling
the problem.
It is generally expected that the domestic financial market will
see an over-supply of capital in 2007, which will be of primary
concern for the authorities.
This opinion is based on two facts: The astronomically high
foreign exchange reserve keeps increasing and domestic bank
deposits are rising with the same strong momentum.
However, both these facts are likely to persist for quite a
while. As long as the country does not change its foreign currency
settlement mechanism, the foreign exchange reserve is not going to
slow its increase because of the strong expectation of renminbi
gains in the long term.
The bank deposits are not going to slow their increase given the
current demographics of China: The average urban family has no more
than three members, which drives the family to save heavily for
their future.
The central bank's various moves to control liquidity in the
banking sector are targeted at these two factors because they are
thought to be the real reasons for the excessive liquidity. But as
we have seen, the moves are far from effective.
The only explanation is that there is another factor behind the
excessive liquidity. And that is the low interest rates under the
government intervention.
The low interest rates, in other words, the low price of capital
on the financial market, are a distorted signal to the market about
the value of money. As a result, money holders become active in the
market seeking more rewarding investments or assets. The price
increases in real estate and stocks are the outcome of such
excessive liquidity.
Therefore, the excessive liquidity in the banking system will
not recede as long as the interest rate policy remains unchanged,
and the investment fever will appear in different fields. Problems
caused by excessive liquidity will pop up in new areas even as
previous ones are pressed down by the government by administrative
means.
The authorities should also sort out the fundamental factors
behind the rise in the foreign exchange reserve.
When the financial markets, both at home and abroad, strongly
believe that the renminbi will quickly appreciate, it is only
natural for individuals and businesses, especially the hot money in
the international market, to try their best to put their money in
China to cash in on renminbi appreciation.
Several of my personal friends in other countries believe they
can make a 25 percent profit if they invest in Chinese properties
with loans from foreign banks. And this viewpoint seems
prevalent.
To curb the inflow of foreign exchange, the renminbi exchange
rate must be kept stable to ease the market expectation of its
appreciation.
Otherwise, speculators on foreign exchanges will always find a
way to convert their currencies into renminbi and the authorities
will see the continuing growth of the foreign exchange reserve.
It is also necessary to facilitate Chinese citizens and
businesses' holding their foreign currencies or their investments
in these fields. They would be reluctant to have foreign currencies
or assets in foreign currencies if they could not find rewarding
investment projects or they believe these assets are in danger of
depreciation.
Of course, the authorities have achieved a solid success in this
field. The launching of Qualified Domestic Institutional Investors
(QDII) in 2006 helps domestic investors find attractive channels of
investment for their foreign currency. And the plan has been warmly
accepted here.
Hoisting the deposit reserve rate has directly cut down the
liquidity of commercial banks, but the decreased liquidity is a
very small percentage of the total holdings, especially for the
larger commercial banks. It will not significantly influence the
business of commercial banks, nor will it impact the stock market,
nor the daily life of ordinary people.
The increase in banks' required reserve ratio is going to have a
limited effect on the real estate market. Despite the overall
shrinkage in bank credit in 2006, the real estate sector still
outpaced the previous year in its growth of bank loans. The banks
may not cut back their loans for the industry after the latest
round of lifting.
To sum up, the central bank's effort to reduce the excessive
liquidity of commercial banks by increasing the deposit reserve
rates will only have partial success. When the authorities change
the low interest rate policy and stabilize the exchange rate of the
renminbi, the excessive liquidity will be reduced
substantially.
The author is a researcher with the Institute of Finance and
Banking at the Chinese Academy of Social Sciences
(China Daily January 11, 2007)