China May Loosen Lending Restrictions After Inflation Slows

By Kevin Hamlin

Sept. 13 (Bloomberg) -- China's central bank may cut the amount of cash it requires lenders to set aside as reserves as inflation slows and economic growth weakens.

Inflation was the weakest in 14 months in August, export growth cooled and industrial output grew by the least in six years, according to data released this week.

The government has already restrained gains by the yuan and loosened limits on the amount of money that banks can lend. Policy makers want to protect jobs and prevent a slump in the world's fourth-biggest economy after four quarters of slowing growth and as the outlook for exports dims, according to economists at JPMorgan Chase & Co., Societe Generale SA and Standard Chartered Bank Plc.

``The government is now likely to heed the calls of the struggling export sector for more substantive monetary-policy easing,'' said Glenn Maguire, chief Asia economist at Societe Generale in Hong Kong. ``We will have an easing in the reserve requirement ratio and potentially even reductions in lending rates.''

The central bank pushed the reserve requirement to a record 17.5 percent in June. A cut, which would be the first since 1999, may come in the first quarter of next year, with the ratio dropping to 12 percent by the end of 2009, according to Maguire.

JPMorgan expects a cut in the fourth quarter, with the requirement falling to 15 percent during next year. Standard Chartered predicts one reduction this quarter and another in the first three months of 2009.

Industrial Production

Industrial production grew last month at the slowest pace since August 2002 on weaker export demand, power shortages and factory shutdowns to reduce pollution for the Olympics.

Inflation slowed to 4.9 percent, drawing closer to the central bank's 4.8 percent target for the year and giving policy makers more room to stimulate growth. The reason was smaller gains in food prices.

Export growth has slowed as the U.S. housing recession and international credit crunch undermine demand. For the first eight months, gains cooled to 22.4 percent from 27.8 percent a year earlier.

China's economy expanded 10.1 percent in the second quarter from a year earlier. That's still the fastest pace among the world's 20 biggest economies.

Signs of softness in the economy have coincided with weakness in asset markets. The CSI 300 Index of stocks has fallen 61 percent this year. The property market could be headed for a ``meltdown'' as home prices and sales decline, Morgan Stanley said yesterday.

`Policy Turnaround'

``The question about a policy turnaround is when, not whether,'' said Huang Yiping, chief Asia economist at Citigroup Inc. in Hong Kong. ``We expect the authorities to abandon the tightening policy bias before the end of the year.''

His reasons were ``stable'' inflation, slowing economic growth and a weakening housing market. Huang didn't have an estimate for the reserve requirement or interest rates.

The key one-year lending rate may be cut once in the fourth quarter and twice in the first quarter of 2009, falling from 7.47 percent to 6.66 percent, said Darius Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong.

In a survey yesterday, he was the only one of seven economists to predict a rate cut this year or in the first quarter of 2009.

The central bank has reined in the yuan's appreciation against the dollar this quarter to 0.2 percent after a 6.7 percent increase in the first half. A stronger currency hurts exporters by making their products more expensive.

China's policy makers have already loosened loan quotas -- restrictions on how much banks can lend -- and raised export-tax rebates for garments and textiles.

Infrastructure spending is a possible tool for stimulating economic growth. Officials are working on a plan for as much as 400 billion yuan ($58 billion) of spending and tax cuts, according to economists and reports in domestic news media.

To contact the reporter on this story: Kevin Hamlin in Beijing on khamlin@bloomberg.net