International | May 21 2007
By Chris Shaw
The People’s Bank of China (PBOC) announced last Friday it was lifting deposit and lending rates and the bank reserve requirement ratio as well as widening the trading band for the Chinese currency in a move that surprised the market in terms of timing but was largely expected.
Given the moves followed a number of comments suggesting Chinese shares were entering a bubble phase it can be seen as something of an obvious reaction, but analysts are divided as to what impact if any there will be from the changes.
With Chinese equity markets having increased by more than 50% this year to levels implying (historic) earnings multiples of about 60x there is little question stocks are expensive, a view recently aired by investors such as Li Ka-shing and supported by Merrill Lynch’s China chairman Liu Erhfei, who recently advised investors to trim exposure to Chinese shares as valuations are too high.
The rate changes – lending rates have been lifted by 0.18%, deposit rates by 0.27% and the bank reserve requirement by 0.5%, are, in the view of Credit Suisse’s head of strategy and co-head of economics Kasper Bartholdy, designed to lift real interest rates back to positive levels, so stemming the flow of deposit funds being withdrawn from banks for investing in equity markets.
Bartholdy sees the action as having little real impact though, as he points out the level of excess liquidity is so high it will take some time for the cumulative rise in lending costs to really make an impact. The “some time” here would seemingly refer to a period of more than a few months given the PBOC has been steadily lifting interest rates for more than a year.
Westpac’s senior international economist Huw McKay agrees, as he sees the moves as being designed to freeze new liquidity rather than impacting on current levels. Having said that, he suggests the move to lift the deposit rate was a sensible one as it will help make savings more attractive and so may slow the rate of money flowing into the equity market.
UBS also sees potential for the changes to have a slight negative impact on the Chinese equity market, though it too sees the move more as one of liquidity maintenance than liquidity tightening. Logan McCarthy of Stone & Associates Research suggests the increases were actually smaller than had been expected, a view shared by Bartholdy at Credit Suisse who expects further hikes in coming periods.
He expects increases for both the lending and deposit rates of an additional 0.54% this year and the same next year, while the reserve requirement is forecast to increase by a further 1% both this year and in 2008. Even allowing for such increases, Bartholdy still expects a reduction in liquidity levels to take some time to be achieved.
McCarthy points out the move to lift the lending rate is at least somewhat pro-active given ongoing concerns capital is not being allocated efficiently throughout the economy, a situation that increases the potential for another round of bad debts to emerge in the banking sector, which would be just the type of outcome authorities are trying to avoid.
In terms of the change to the currency trading band the experts are in agreement the move was primarily political, as since the existing 3% band has never really been tested a move to a 5% range should have no real impact.
While it may please the Americans leading into upcoming economic talks, Bartholdy still expects the renminbi to appreciate by 5-7% against the US dollar over the course of this year.
