A little less tight

Beijing begins to relax monetary policy

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02 Dec 2011
Week in China

When British economist John Maynard Keynes was accused of inconsistency in his policy advice, he memorably retorted: "When the facts change, I change my mind. What do you do, sir?"

And the facts seem to have been changing fairly fast in China lately – not to mention in other parts of the world. This has led to a "change of mind" for Beijing's top policymakers too.

For most of the year, they have been focused rather single-mindedly on curbing inflation, including skimming the froth off an overheating property market. This has been pursued via a series of tightening measures based around involved interest rate rises, restrictions on bank lending and curbs on real estate purchases.

The result? Headline inflation fell in October to 5.5%, and most think the trend will continue downwards. On Monday the Organisation for Economic Cooperation and Development (OECD) predicted that inflation will fall to 3.8% next year.

The measures to rein in the property market have also taken their toll. Prices are falling in many cities, sales of new apartments are down and new construction is often being halted. Some developers are facing cashflow problems (see WiC128 for a more detailed look at the property slowdown).

Growth is set to overtake inflation as Beijing policymakers' top policy concern.

Indeed, the government's tightening measures may have worked too well, with the external environment – particularly the paralysis in the EU, China's biggest export market – adding a further drag on the economy.

One worry is that this is hitting export-driven firms in cities like Wenzhou hardest, and could trigger a crisis in the shadow banking system (See WiC127 and 124).

Weak purchasing manager data from HSBC – which suggested manufacturing was contracting – also spooked investors recently, sparking a return to hard landing talk. GDP growth has fallen for three straight quarters.

Japan's Nikkei agrees that there is evidence that the real economy is struggling. At Kobelco Construction Machinery's factory in Hangzhou output has slowed due to falling orders. "We are only using about 50% of our production capacity at present," said Kobelco senior executive officer Kazumitsu Takiguchi, who oversees the firm's Chinese operations. He blamed a pullback in infrastructure spending.

The Chinese leadership has also recognised the wider context, with Vice-Premier Wang Qishan saying that he feared the global economic downturn would last "a long time".

So in a switch of gears Beijing is now shifting from tightening policies to those designed to counter some of the dangers to future growth.

"Growth is set to overtake inflation as Beijing policymakers' top policy concern," HSBC economist Qu Hongbin predicted last week. And he was right. The first signs of a repositioning: six rural credit cooperatives in Zhejiang were allowed to reduce their reserve-requirement ratio by 50 basis points to 16% last Friday. Also telling was a move by the Beijing municipal government to relax a few of its curbs on property sales. Last Friday it announced that the ceiling had been raised for an 'ordinary home' from a previous maximum of Rmb2.58 million ($404,000) to Rmb5.44 million. The definition matters as only so-called ordinary homes merit tax credits. The Shanghai Daily has been speculating that other cities may follow.

But the major news came late this week when the central bank cut the banking sector's reserve ratio requirement by 50 basis points. "This marks the official start of China's monetary easing," commented HSBC's Qu, and the Wall Street Journal noted that this was the first such cut in three years.

It signalled that policymakers were focused on stimulating growth again "even at the risk of reigniting a property bubble," the newspaper thought.

There is a political context here too. In the coming 12 months Hu Jintao is set to hand over the presidency to Xi Jinping, and the tradition is to ensure that such transitions occur against a healthy economic backdrop – meaning a GDP growth rate of at least 8%.

Qu of HSBC now forecasts that it will exceed that, at 8.5%.

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