Op-Ed Contributors

Curbing excess domestic liquidity

By Liu Yuhui (China Daily)
Updated: 2010-05-25 07:55

Measures such as low long-term deposit rates and investment spree only help wealth flow to certain interest groups

The People's Bank of China issued two sets of bills on Thursday at opposite rates, as domestic banks faced with tighter monetary conditions seek higher returns from longer tenors.

The central bank set the yield for 6 billion yuan of three-month bills at 1.4492 percent, or a rise of 4 basis points, a move that reflected extremely weak demand from domestic banks.

Conversely, the yield for the three-year tenor fell by 2 basis points to 2.70 percent, suggesting that even the 120 billion yuan on offer was not enough to meet domestic banks' strong demand.

The divergence underscored the extent to which the country's monetary conditions have tightened in the last few weeks, particularly after the implementation of the higher reserve requirement ratios by the central bank on May 10, the third rise this year that locked up an estimated 300 billion yuan.

China is faced with excess liquidity despite three reserve requirement ratio hikes and other moves to drain funds from the market. A relaxed monetary policy has been adopted in China over the past years to curb its economic slowdown in the context of the global financial crisis.

The value of assets held by the country's central bank has so far risen to 23 trillion yuan from the 5 trillion yuan at the end of 2002, statistics show.

The Chinese authorities have excessively depended on microeconomic measures, such as credit control, to manage some of its macroeconomic problems, believing that its competent administrative means have given the country some advantages over Western countries in macroeconomic regulation. However, any strict administrative limitations or barriers will not be able to prevent profit-pursuing private funds flowing to those sectors that will fetch high returns.

The strong expectation of inflation, together with a loose monetary and tightened credit policy, has resulted in bullish demand within the country for government debt, as indicated by the orders for three-year central bank bills doubling the volume of its issuance. That is also indication that the public has very low expectations about the country's long-term deposit rates.

Friedrich von Hayek, an Austria-born economist, believed that enterprises and ordinary people would hold a very low, and even negative, expectation on the long-term rate after a relaxed monetary and an expansive credit policy is adopted.

As a result, they would choose long-term investment options in certain areas to prevent property devaluation. This, however, will give rise to the unreasonable distribution of resources or an unscientific investment spree, both stoking bubbles.

The de facto existence of a negative interest rate in China has pushed the country to develop in this direction. The country's consumer price index (CPI) is now higher than the interest rate of its benchmark one-year deposit rates, which has precipitated domestic investor fears over inflation and pushed them to seek new investment channels.