China May Pare Economic Stimulus to Control Inflation

By Bloomberg News

Oct. 23 (Bloomberg) -- Chinese officials may be preparing to reduce monetary stimulus that propelled growth to 8.9 percent in the third quarter and led the world out of recession.

The economic expansion the government reported yesterday exceeded the 7.9 percent gain in the previous three months and pushed stocks lower in Asia and Europe on concern the central bank may tighten monetary policy. On the eve of the release, the cabinet signaled that inflation concern will play a greater role in setting policy.

China’s government may set a lower loan target for 2010 after new lending reached a record $1.27 trillion in the first nine months of 2009, UBS AG said. Policy makers may raise interest rates in the first quarter of next year, before the U.S., Japan and euro area, according to ING Groep NV.

“Monetary stimulus is becoming unnecessary,” said Kevin Lai, a Daiwa Institute of Research economist in Hong Kong. “The risk is that this aggressive monetary expansion will spill into stocks and property, creating a bubble and making a hard landing for the economy more likely.”

China may raise banks’ reserve requirements, or the proportion of deposits that lenders are required to set aside as reserves, as early as the end of December, according to Lai and analysts at UBS and Credit Suisse Group AG. Currently, the ratio for the nation’s biggest banks is 15.5 percent, down from last year’s high of 17.5 percent.

Borrowing Costs

The People’s Bank of China may begin boosting rates in the first quarter of 2010, Lai said. The benchmark one-year lending rate is at a five-year low of 5.31 percent.

The MSCI Asia Pacific stock index fell 1 percent yesterday to 119.31, and China’s Shanghai Composite gauge slid 0.6 percent. In Europe, the Dow Jones Stoxx 600 benchmark slipped 1.2 percent, the steepest decline in almost three weeks.

China’s State Council said Oct. 21 that policy focus in coming months will need to “balance” the need to aid growth with “the need to better manage inflationary expectations.” That was a shift from a statement in June that didn’t mention price pressures.

Central bank Governor Zhou Xiaochuan said this month that China’s “moderately loose” monetary policy, adopted to combat the impact of the global recession, was exceptional and probably unprecedented for the nation.

‘Prudent’ Policies

“Even after the Asia financial crisis, when we adopted proactive fiscal policies, we maintained a prudent monetary policy stance,” Zhou said at a lecture in Beijing, referring to the 1997-1998 turmoil. “As a transitional economy with rapid growth, China’s monetary policy should always lean towards relatively tight.”

China’s two-year $586 billion stimulus package, announced in November last year, spans earthquake reconstruction work, roads, railways and low-cost housing.

Fan Gang, the academic member of the central bank’s monetary policy committee, said yesterday in an interview in Toronto that the fiscal stimulus must continue for another year to allow for a “full recovery in 2011.”

Besides extra lending and spending to counter an 11-month slide in exports, China also halted the yuan’s gains against the dollar from July last year, to aid exporters.

Barclays Capital analysts said yesterday that currency appreciation may play a role in policy tightening next year as the government tries to control inflation.

Yuan Appreciation

Contracts based on the yuan’s value in a year imply an appreciation of China’s currency of 2.8 percent, compared with 0.5 percent two months ago. Twelve-month non-deliverable forwards touched 6.5440 per dollar on Oct. 20, the highest level since August 2008.

Yesterday’s data showed industrial production climbed in September by the fastest pace in more than a year as tax cuts and subsidies spurred record vehicle sales in the nation for General Motors Co. and Volkswagen AG.

Retail sales recorded the biggest year-on-year increase since December, excluding seasonal distortions. Consumer prices rose 0.4 percent in September from August.

For the first nine months of 2009, the economy grew 7.7 percent, with domestic demand accounting for all of the advance. Consumption, including household spending, contributed 4 percentage points and investment added 7.3 percentage points. Trade shaved off 3.6 percentage points from the total.

The government may limit new lending to 7 trillion yuan for all of 2010, compared with 8.67 trillion yuan already this year, said Wang Tao, an economist at UBS in Beijing.

Asset Bubbles

The 68 percent gain in the Shanghai Composite Index this year and an 11 percent jump in property prices in the southern city of Shenzhen in September from a year earlier highlight the risk of asset-price bubbles.

Qin Xiao, chairman of China Merchants Bank Co., said this week that it’s “urgent” for the central bank to tighten policy to avert bubbles, in comments published in the Financial Times.

Royal Bank of Scotland Group Plc raised yesterday its forecast for China’s economic growth this year to 8.5 percent from 8 percent and UBS, Barclays Capital, Credit Suisse and HSBC Holdings Plc also increased estimates.

The acceleration in China’s growth affirmed it as the world’s fastest growing major economy. The U.S. Commerce Department is projected to report next week that American gross domestic product rose at an annual rate of 3.1 percent in the third quarter from the previous three months.

‘Rush for the Exit’

Policy makers in the U.S. and Europe have given no sign they are yet ready to raise rates. The Federal Reserve said last month it aims to keep the benchmark rate near zero “for an extended period.” European Central Bank Governing Council member Axel Weber said yesterday there is “surely no need to rush for the exit” of monetary stimulus.

China’s acceleration will help pull along the Asian region and benefit the emerging-market currencies, according to Sebastien Barbe, head of emerging markets research and strategy at Calyon, the investment-banking unit of Credit Agricole SA.

“The strong numbers are good news for China and also for the rest of Asia, as China’s demand fuels the rebound of regional trade,” Barbe said in a note to clients yesterday.

To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net; Li Yanping in Beijing at yli16@bloomberg.net