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China drains cash to curb liquidity

By Simon Rabinovitch in Beijing

China drained a record amount of cash from its banking system this week, counteracting an explosion in credit growth that had stoked concerns about inflation.

The central bank withdrew Rmb910bn ($146bn) from the economy via open market operations over the past three days, its biggest weekly cash drain ever.

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The Chinese stock market, which is driven heavily by liquidity conditions, sold off sharply after the central bank’s move. The Shanghai Composite, the country’s main index, shed 3 per cent.

The move was partly a technical reversal of liquidity injections made before last week’s Chinese New Year holiday, but analysts said it also heralded a cautious shift to tighter monetary policy as the world’s second-largest economy heated up.

“It is a signal that they are going to change the policy stance. It’s just too loose,” said ShenJianguang, an economist with Mizuho Securities. “The credit issuance in January was scary.”

Chinese credit issuance – which includes lending by banks and financing provided by non-bank institutions – surged to a record Rmb2.5tn in January, surpassing the monthly totals in early 2009 when the government unleashed a stimulus surge to battle the financial crisis.

In a monetary policy report published at the start of February, the People’s Bank of China said that controlling inflation was a priority as the economy’s recovery strengt hened. China slipped to 7.8 per cent growth last year, its slowest in more than a decade, but it has been speeding up since the end of the third quarter. The surge in lending could presage faster growth and higher inflation this year if left unchecked.

In its regular open market operations this week, the central bank allowed Rmb860bn of previously issued reverse repurchase agreements to expire, in effect undoing short-term liquidity injections made before the New Year holiday when demand for cash spikes.

On top of that, it also issued a further Rmb50bn in repurchase agreements, draining extra cash from the economy. Moreover, it used longer tenors for a portion – as long as three months instead of the usual 7-day or 28-day duration – to keep the money locked up for longer.

“It’s a normalisation of monetary policy. There is no doubt that there is simply too much liquidity in the system,” said Yao Wei, an economist with SociétéGénérale.

The government has also started to tighten its grip on the property sector after a rebound in housing prices. On Wednesday the State Council, or cabinet, said that cities with excessively fast price increases must implement stricter curbs on purchases. In recent weeks local governments in the wealthy provinces of Guangdong, Zhejiang and Jiangsu have all taken steps to increase the cost of mortgages to homebuyers.

China’s new home prices rose 1 per cent in January from a month earlier, according to Soufun Holdings, a real estate website that surveys 100 major cities. A property recovery bodes well for the construction industry, a key driver of the Chinese economy, but the government is determined to keep the housing market under control after working for nearly three years to deflate bubbly prices.