Interpreting China’s Move to Constrain LendingAdrienne Penake - Tuesday, January 12th, 2010

In a surprise move today, China’s central bank increased reserve requirements for most of the commercial banks in the country. Banks must now hold 16% of their deposits on reserve, which is an increase of half a percent. Apparently, many Chinese banks make most of their lending decisions in the first half of the year. This year, many have moved to do so in the first few months of 2010, anticipating tighter lending restrictions later this year. The Chinese government wanted to contain that flurry of lending before it was issued. This move raises the question of whether or not China’s economy is currently overvalued. The government is putting on the breaks with the following implications:
  • The Chinese economy has gotten ahead of itself. Many months of robust capital has propped up a new asset bubble that the government is trying to reign in.
  • Inflation is rapidly accelerating. That will lead to higher rates and difficulty maintaining their currency peg.
  • China is experiencing a loose credit binge. Cheap money rates and high growth prospects have created an unsustainable environment.
The real question to answer is whether this is a preventative measure or if there is already an asset bubble caused by excessive financial leverage. While the next several months should help answer that question, there is no doubt that an unexpected tightening of the credit environment is a signal to the international community to beware of higher rates and a containment of growth expectations going forward.
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