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Caveat on tightening policy
(China Daily)
Updated: 2008-07-29 13:51

Caveat on tightening policy

Shortly after the central bank released its latest statistics, the People's Daily interviewed Li Yang, director of the Finance Institute of Chinese Academy of Social Sciences. In the interview, Li, a prominent expert from the top think tank, explained the implications of the figures and the possible policy changes in the second half. The following is an excerpt from the interview.

Q: Since China's GDP growth and inflation both slowed down in recent months, do you think the government should adjust its tightening measures?

A: The factors causing the ongoing inflation are very complicated. Supply shock, price hikes of primary goods in the international market, rising labor costs and adjustment of resource product prices have all contributed to the trend. Some of these factors are irreversible. So mild price hikes will continue in the near future.

Since supply shortage is not the main reason for the current inflationary pressure, tightening monetary policy will only have a limited impact in curbing inflation. If we use an even tighter monetary policy in the second half, the impact could even be negative.

So in the second half, we need to maintain a stable credit environment, keeping loan growth, money supply and interest rates at a stable level. Personally, I think since consumer inflation has eased and the economy has slowed down, we should be prudent in using monetary tools, especially interest rates and the deposit reserve requirement ratio.

Q: This June alone, China's foreign exchange reserve grew 35.73 percent year-on-year, surpassing $1.8 trillion. In the first half, the nation's foreign exchange reserve increased $280.5 billion. Such strong growth has given rise to concern that hot money is flooding into China. Do you agree?

A: I don't. We should have an accurate definition of "hot money." A key aspect of hot money is its high liquidity. The money should be able to invest in assets with high liquidity and converted into foreign exchange freely. In this sense, it's difficult to imagine that a huge amount of hot money exists in China.

First, let's look at the capital markets. Since the fourth quarter of last year, the stock market has been declining. Transaction volume of the property market has been shrinking. And the bond market is in turmoil. Besides bank deposits, the capital markets mentioned above have little appeal to speculators.

But bank deposit has little allure for speculators. It's impossible for a massive scale of capital to stay in banks. Meanwhile, the interest return of renminbi deposits is not very high. Once "hot money" is put into bank accounts, it has to sacrifice liquidity.

For example, if Hong Kong investors convert their HK dollars into renminbi and put the money in deposit accounts on the mainland, they can earn 8 percent more than if they keep the money in Hong Kong. This extra gain comes from the 5 percent appreciation of the renminbi and the 3 percent difference in interest rates.

But such money shouldn't be categorized as hot money as they do not harm the stability of the financial markets. Only the capital that seeks a return by attacking China's financial system could be seen as hot money. For the time being, the proportion of hot money in China's foreign exchange reserve is not very high.

As for convertibility, under the current foreign exchange regime, there is still a significant number of restrictions for foreign capital to enter and leave China.

Q: So what's your estimate of hot money in China?

A: If we study the money that could easily retreat from China in a short time, the volume is less than $280 billion. Even if we factor in the money that needs a longer time to pull out, it's at most $520 billion, which can hardly cause any substantial impact on the Chinese economy.

Q: China's renminbi loan growth only expanded 14.12 percent this June. As we know, most of the slowdown was due to the decline in property development loans. How do you think the tightening policy will change the real estate market?

A: Chinese developers often rely heavily on bank loans to finance their projects. The current credit tightening measures will certainly have serious impact on the prospects of the property market and some developers might go bankrupt as a result. On the other hand, the consolidation may help the sector's long-term development.

However, since the real estate market is closely related to the banking sector, its fluctuations might have a significant impact on the economy. Thus we should be very careful while trying to contain the bubbles in the industry.

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