February 19,2011

China's Lending Curb: An Indication to Harness Total Social Financing?

By Wang Qing, Hong Kong

RRR Hike again: Liquidity conditions have improved significantly in the last two weeks, courtesy of the phase-out of CNY seasonality and a rising amount of matured bills and repos (Exhibit 3). In this context, the RRR hike by PBOC today is not a surprise to us. We believe this hike is mainly targeted at absorbing the liquidity flowing back to banking system after Chinese New Year and tackling another big wave of matured bills and repos (up to Rmb1.1tn for February and March in total). The frequent policy maneuvers by PBOC since early 2011 are consistent with our call that the tightening to control inflation would be "front-loaded" in 2011. We expect more rate hikes (two more in 1H11) coupled with RRR hikes (or differentiated RRR) in the pipeline to keep inflation in check upfront.


PBOC open market operations: Against the backdrop of improved of liquidity conditions after Chinese Lunar New Year, PBOC's open market operations started to normalize this week with bill issuance rebounding to Rmb11bn. In addition, after suspension for about one month, repo sales were re-launched this week to assist liquidity management. While PBOC withdrew Rmb51bn through bill and repo sales in total, this week continued to end up with Rmb55bn of net liquidity injection given Rmb106bn of matured amounts. Given the frequent RRR hikes by PBOC against continued liquidity injections through open market operations, we believe PBOC still prefers to use more-effective but less-costly RRR for liquidity management during the tightening cycle.


Divergence between short-end and long-end SHIBOR rates: Except for a 15.4bp gain in seven-day rate, short-end SHIBOR rates with tenure at three months or below continued to moderate this week with a more than 40bp fall in overnight, one-month and three-month rates. However, the long-end SHIBOR rates continued to edge up, led by a 13bp gain in the 12-month rate. The divergence between the short-end and long-end SHIBOR rates should be ascribed to the intrinsic logic that short-end rates are driven largely by liquidity conditions while long-end rates are more bounded to interest rates and inflation outlook. Given the ample liquidity with in the market, we do not think SHIBOR will react violently to this RRR hike as it did in January.


Unveiling the "Total Social Financing" by PBOC


PBOC posted a comment from Mr. Sheng Songcheng (Director General of Statistics Department of PBOC) on "Total Social Financing" and its implications in practice yesterday. After being raised during the central economic working conference in December 2010, the new concept of "Total Social Financing" has been frequently recommended by senior government officials as a much-superior indicator of loan growth or existing monetary aggregates (M1, M2) with much-higher correlations with the real economy . The detailed explanation by Mr. Sheng unveiled the true face of this new concept for the first time by providing details of what is included in "Total Social Financing" and why it outperforms other existing indicators.


Total Social Financing = RMB Loans + Foreign Currency Loans + Entrusted Loans + Trust Loans + Bank Acceptance + Corporate Bond + Stocks of Non-financial Enterprises + Insurance Claims + Property Investments of Insurance Companies + Others


On the back of rapid progress of financial deepening, direct financing has become increasingly important. According to the PBOC release, the share of RMB bank loans in total social financing declined to 55.6% in 2010 from 92% in 2002. In this context, it should be biased to target only new loan creations for policy operations. PBOC cited 2010 as an example, when new loan creations slid to Rmb7.95tn from Rmb9.6tn in 2009. However, PBOC indicated that real economy raised an additional Rmb3.47tn from off-balance sheet operations, which grew by Rmb2.33tn compared with 2009 and accounted for 24.2% of total social financing in 2010. In this sense, the liquidity conditions in 2010 should be even more loosening than in 2009 if those off-balance sheet financings are added back in ((Rmb11.4tn in 2010 (Rmb7.95tn + Rmb3.47tn) vs. Rmb10.7tn in 2009 (Rmb9.59tn + Rmb1.14tn)). In light of stricter restrictions as the result of escalated regulations, we believe that it will be more difficult for banks to avert regulations through off-balance sheet operations this year. In this context, even if new loan creation reached Rmb7-8tn for 2011, the overall liquidity conditions should be quite tight, in our view.


We noted before that "the authorities may indicate that they will track and target the amount of total financing of all forms in the economy instead of narrowly focusing on the amount of bank lending (or loan quota)" (see China Economics: Dynamic Differentiated RRR Adjustment to Become a Primary Monetary Policy Tool, Jan 10, 2011). We believe that this move by PBOC has demonstrated further significant progress in the sophistication of monetary operations.

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