Effective monitoring mechanism needed to prevent speculation in the housing market and food price hikes

The People's Bank of China announced on Saturday that it will lower the reserve requirement ratio for domestic commercial lenders by 50 basis points, effective from Friday.

The reduction means the reserve requirement ratio will decline to 20 percent for major banks and 16.5 percent for small and medium-sized lenders. It is the second time China's central bank has made such a cut this year and the third time since December 2011.

The latest reduction in the reserve requirement, which is expected to release about 400 billion yuan ($63 billion) into the market, is believed to be a response by the monetary authorities to the country's discouraging economic prospect.

The latest economic data indicate that China is facing a difficult macroeconomic situation. The country's Producer Price Index was down 0.7 percent from a year earlier in April, falling for the second consecutive month to its lowest point since December 2009. From January to April, the country's fixed asset investment grew 20.2 percent from the same period last year, its lowest growth since 2003. Meanwhile, if the price factor is deducted, its industrial added value grew only 9.3 percent in April, a decline of 2.6 percentage points from March and 4.1 percentage points from last April.

As an important parameter to measure national economic growth, the country's power generation volumes only grew 3.7 percent in April, a drastic decline from the 7.2 percent growth in March. All these discouraging economic signs point to a slower growth of the world's second largest economy.

A day before the Saturday announcement, the PBOC's own statistics indicated that the newly increased loans issued by the country's commercial banks was $681.8 billion in April, a decline of $61.2 billion from a year earlier. It also declined 32.5 percent from the previous month. In the context of a tightened monetary policy, a moderate decline in the country's bank credit comes as no surprise, but such a drastic credit decline is still beyond people's expectations, especially amid repeated central government statements in recent months that some slight changes will be made to the country's established monetary policies to adapt itself to the changed economic situations at home and abroad.

While applauding the positive effects to be produced by the latest reserve cut, we should also look at the underlying factors behind the current economic slowdown. Is it the insufficiency of bank loans or the lack of investment enthusiasm among the massive number of domestic enterprises that has resulted in the looming slowdown? An analysis of the composition of the country's bank credit in recent months offers an answer to this question.

Statistics from China's central bank indicate that the additional loans acquired by other departments and the country's non-financial sector reached $535.1 billion in April, of which only $126.5 billion was middle and long-terms loans, the rest was largely short-term loans or bank bonds.

The decline in middle and long-term bank loans reflects enterprises declining aspirations for investment and production expansion, a trend that is compatible with the country's ongoing efforts to push for economic structural adjustments, instead of banks' reluctance to lend to them.

Against the backdrop of a broader economic slump, a voluntary reduction by domestic enterprises in their credit demands is understandable and also a rational choice. Under these circumstances, to lower banks' reserve requirements will give a sizeable boost to bank credit, but that is unlikely to completely change the slump in the national economy. On the contrary, it will possibly cause more funds to flow to speculative markets and add to economic uncertainties.

The April data published by the National Bureau of Statistics reveal that the consumer price index maintained a generally steady momentum that month, but food prices remained high. Vegetable prices in April grew as much as 27.8 percent year-on-year, meaning that the country is still facing an uphill task to rein in intractable prices.

At a time when domestic enterprises have no motivation to increase their credit demands and a strict and effective regime aimed at monitoring where newly released loans flow has not yet been put in place, there is a strong likelihood that the increased liquidity following the latest reserve cut will flow to the food market. Should this occur, it will inevitably further push up prices and exacerbate inflation pressures.

Such a painful lesson is still fresh in the minds of the Chinese public. The relaxed monetary policies the country adopted in 2008 to curb the national economic slowdown in the context of the global financial crisis released excessive liquidity into the domestic market. Because of its outgrowing the real economic demands, a large part of released liquidity flowed to the housing market and agricultural products, causing the prices of homes and some agricultural products to skyrocket.

Despite the possibly positive role of increased liquidity in curbing an economic slowdown, the country's monetary authorities should also not ignore the likelihood that the increased liquidity will push prices further higher if no effective monitoring mechanism is put in place.

The author is a Beijing-based economics commentator.