Friday, December 10, 2010

No More loose Monetary Policy

The Political Bureau of the Communist Party of China Central Committee, chaired by President Hu Jintao on 3 December 2010, decided that it will switch its monetary policy stance from moderately loose to become prudent next year to curb the rising inflation and also to maintain economic growth at sustainable pace.

However, China will still continue its proactive fiscal policy in the year 2011.

In order to increase the focus, flexibility and effectiveness of macroeconomic regulating policy in 2011, China has to set two goals: keeping economic growth and also curbing the drastic increase in inflationary pressure.

Keeping economic growth needs a policy of fiscal expansion while fighting inflation needs a tighter monetary policy. The existing economic situation in China requires a combination of the two.

The Chinese Political Bureau also stated that more measures will be in place to ensure sufficient market supplies, to stabilize prices level and to regulate market order in next year.

The Chinese central bank, which is under high political pressure due to recent criticisms for the delayed action on raising interest rates until 19 October 2010, fear that the so-called QE2 (Quantitative Easing) will really become "kill me too".

In fact, the Chinese central bank already raised the reserve requirement ratio for banks twice to 18% later in November, indicating its concern about rising inflation expectation as liquidity from abroad grows.

On 17 November 2010, the China premier Wen Jiabao also further confirmed the direction of harsh administrative tightening measures, including temporary price controls when necessary, and has cracked down on hoarding and speculation to prevent price hikes.

Although these actions mostly addressed worries stated earlier in our inflation warning, China inflation remains a risk as the real benchmark 1-year deposit rate is approaching our warning level of -2% (now it is 2.5% - 4.4% = -1.9%).

Deposit level has started to fall because Chinese savers see the value of their holdings eroded. This encourages them to look for better places to put their money and, as long as the trend of negative real deposit rate continues to extend, it will eventually fuel asset-price bubbles forming.

As the chance of real deposit rate to exceed -2% remains high in the near future, we therefore still expect Chinese Central Bank to raise interest rates soon, hopefully before the end of 2010.

Last but not least, we also decide that stocks of utilities, electricity and coals will not be our picks in 2011 owing to the risk in government price controls.

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