China May Adopt Tighter Monetary Policy

Last Updated: 28, February 2013

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Authorities should drain more cash from the financial system and enhance oversight of banks’ off-balance sheet business, said the Chinese State Information Centre, as the risks of overheating outweigh potential economic slowdowns.

Citing a strong rebound in the fourth quarter and an improvement in the country’s economic outlook, the Centre, the research arm of the National Development and Reform Commission, said in a report on Wednesday that China should adopt a tighter monetary policy to mitigate inflationary risks.

According to the Centre, inflation is expected to reach 3.11 percent in 2013, up from 2.6 percent last year, while economic growth is projected at 8.2 percent.

“For now, risks of overheating are bigger than those of a deep slowdown,” said Sun Mingchun, head of China research at Daiwa Capital Markets.

The report is the latest indication that the central bank and other institutions will step up efforts to counter risks from rising inflation, rebounding demand and record credit expansion as the world’s second largest economy recovers from its weakest growth in 13 years.

Last week, the People’s Bank of China withdrew a net 910 billion yuan ($146 billion) from the financial system, the first time in eight months and more than double the previous record according to data compiled by Bloomberg since 2008.

“The very fact that the PBOC conducted the draining operation is a hawkish signal. Clearly, the central bank is trying to send a message that it will not tolerate too easy liquidity conditions,” said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB .

Louis Kuijs, an economist at RBS, added that there was a possibility of monetary tightening in the second half of the year, even though he expects monetary policy to remain on hold in the coming months. “If we start to see the recovery really taking off, then later in the year, we can expect some tightening measures,” Kuijs said.

But the PBOC is unlikely to adjust interest rates or reserve requirements in the short-term, the Centre said, and will instead rely on open market operations to control the amount of liquidity in the system.

The report also highlighted income redistribution as a fundamental policy goal and urged policymakers to do boost domestic consumption levels. Most analysts and academics agree China needs to transform its growth model to allow consumption, not exports and investment, to drive activity.

However, the PBOC will be reluctant to tighten liquidity too drastically because of the high levels of financing required for the country’s urbanisation push – one of the key agendas for China’s so-called fifth generation of leaders who are expected to take helm in March.

In December, the PBOC highlighted the need to control risks as an objective and said China will stick to a prudent monetary policy in 2013, an indication that Beijing won’t be changing direction when the new government takes over.

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