China Tightens Monetary Policy

The People’s Bank of China announced yesterday that it had increased the yield on its three-month central bank bills to 1.3684 percent from 1.328 percent. This is the first increase in the yield of the weekly sale of BofC-backed securities since mid-August, and is widely seen as a move to tighten monetary policy to head off the potential for economy-wrecking asset bubbles.

[mserve id=”Central_Bank_PBOC.jpeg” align=”left” width=”250″ caption=”People’s Bank of China ” alt=”Peoples Bank of China PBOC Central” title=”People’s Bank of China”]

After struggling through the global downturn for much of 2008, China’s economy has roared back and is expected to close out 2009 with growth of close to 8 percent. Certainly, the 900 billion or so yuan (US$132 billion) invested by the government and the Bank of China as part of China’s overall stimulus plan played a major role in the turnaround, but this return to growth brings with it fears of inflation and burgeoning asset bubbles; particularly with respect to property values and equity prices.

As one of the world’s largest exporters of manufactured goods, a great deal of foreign currency flows into China, most of which is in US dollars. The Bank of China buys up much of the foreign currency and issues renminbi (Chinese yuan) to pay for the currency, and to keep a lid on inflation from all the cash floating in the economy, the Bank sells bank bills to financial institutions at a posted yield. The money received from these sales – already converted to yuan – can then be “removed” from the money supply if the Bank feels there is too much cash available in the system.

Meanwhile, critics of China’s monetary policy argue that while the Bank of China claims to use this approach to hold the line on inflation, it also does this to intentionally keep the yuan weak. Deliberately devaluing the yuan makes it possible for China to keep the costs of its exports lower than those from other countries and provides China with a competitive advantage over other jurisdictions.

The buying of foreign currencies in this manner is how China has managed to amass currency reserves of nearly $2.3 trillion in US dollars as of the end of September. Recent losses in the dollar have cut into the value of these reserves and this has been a point of contention with Chinese officials.

In addition to the increase in bank bill yields, there have been other policy change announcements clearly intended to combat potential asset bubbles. On Wednesday, the Bank issued a blunt waning to the nation’s banks cautioning against being too aggressive in lending capital to developers over fears that property values are appreciating too quickly. Anecdotal evidence suggests that property values in the more desirable communities have more than tripled in the last twelve months alone and has encouraged developers to concentrate on higher-end units while ignoring the needs of middle and lower-income buyers who are finding it increasingly difficult to find affordable housing.

In addition, key changes approved by regulators just this week have loosened equity market rules that will now allow margin trading and the ability to short individual stocks. It is also expected that stock index futures will soon be available and these amendments will provide greater opportunities for investors to hedge stock market positions against possible losses. Prior to these updates, short-selling was not possible on China’s equity exchanges.

These changes mark a significant shift in China’s approach to regulating its investment industry and come at a critical time for the evolution of the growing securities industry in China. The two largest equity markets – the Shanghai and Shenzhen stock exchanges – suffered through bouts of tremendous volatility over the past year, and the government is hoping that allowing traders to take contrarian positions, will help balance prices while avoid the potential for asset bubbles.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.