Credit Tightening: Good News For Inflation

Bank of China building, Beijing

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When inflation hit 21.7 percent in 1994, Zhu Rongji, China’s then economic czar, literally shut down lending by assigning tough credit quotas to the regional banks. Zhu told bank officials that they would lose their jobs if they exceeded his credit quotas. As a result of Zhu’s tough administrative measures, inflation in China slowed to 15 percent in 1995, 6 percent in 1996, 1 percent in 1997, and minus 2.5 percent in 1998.

While today’s inflation problem in China is nowhere near as acute as it was in 1994, China’s monetary officials are once again taking tough measures to get prices under control. Last Thursday, China’s central bank said it will raise the reserve requirement ratio for banks by a further one-half of a percentage point from May 18, in a move to address inflation concerns by locking up liquidity in the banking system. So far this year, the People’s Bank of China has raised the reserve requirement ratio once per month for a total of five hikes.

Anecdotal evidence has suggested for some time that China’s tough credit policies are having an impact, particularly in the real estate sector. Our banking friends have been telling us of developers willing to pay 18 percent or more for credit, if they can get it at all, and the predictions are that many will go out of business this year. In general, our sources tell us that as little as 20 percent of loan demand is currently being filled by the country’s banks.

Empirical evidence of the impact of China’s credit tightening is now starting to turn up as well. In construction machinery, for example, sales of wheel loaders in April were down 28 percent, and excavator sales were down 40 percent, from the sales levels achieved in March, reflecting a slowdown in fixed asset investment. Car sales are also sluggish. In April, retail sales of passenger cars slowed to 4.2 percent, the worst result since January, 2009.

For these reasons, at least some economists believe that China may have already seen the worst on the inflation front. Andy Rothman, the China Macro Strategist for CLSA Asia-Pacific Markets, believes that China is near the peak in food-price inflation and close to the peak in the overall rise in the Consumer Price Index for this cycle. Despite the 5.3 percent rise in consumer prices in April, Andy is sticking with his forecast of 4.5 percent average CPI for the year.

With the full impact of China’s credit tightening measures still to be felt, and the recent weakness in global commodity prices, Andy may very well be right.

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