China tightens again--speculation rises on when the big moves will come

05/03/2010 11:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Another order from the People’s Bank of China for China’s banks to increase reserves has set off a wave of speculation about how many more reserve increases are in the cards, when the central bank might raise its benchmark interest rates, and when China might decide to end the peg of its currency the renminbi to the U.S. dollar.

First, what we actually know.

On May 3 the People’s Bank told the country’s banks to increase their reserve ratio another 0.5 percentage point to 17% for large banks and 15% for smaller lenders. The new requirement will go into effect on May 10. This is the third increase in the required reserve ratio in 2010. And it comes as bank regulators have told banks to look at their loan books and provide estimates of any uncollateralized loans.  Banks that are unable to find collateral on a loan may be required to downgrade the loan, bank regulators have said.

The goals of this latest round of moves are the same as in previous moves: to reduce bank lending in order to slow the economy and to crack down on unsecured loans, especially to shell companies set up by local governments, which that have been used to speculate in stocks and real estate.

Loan growth has slowed in 2010 but Chinese banks still made $380 billion in new loans in the first quarter.

Second, the speculation.

This morning Bloomberg reported that Beijing News had reported that an unidentified official with the China Banking Regulatory Commission’s branch in Guangdong province had said that the People’s Bank would raise reserve requirements to 18%.

Now I don’t know why this prediction by an unnamed official deserves any more credibility than the prognostications of my Aunt Sally, but I do understand the intense interest in how much higher the reserve requirements will go.

The theory is that as long as the People’s Bank is raising reserve requirements it won’t raise its benchmark interest rate. Such an increase in interest rates is a central bank’s big gun and has much greater effects all across an economy than an increase in bank reserve requirements does. In its history the People’s Bank has been extremely reluctant to raise or lower benchmark interest rates. The last time that bank adjusted that rates was in December 2008.

Investors worried that the central bank might slow economic growth too quickly have their eyes focused on any move in the benchmark interest rate.

The increase in reserve requirements also set off another round of speculation about China’s currency. By pegging the renminbi to the U.S. dollar Beijing has lost an important tool to fight inflation and those of us who are convinced that inflation in China is close to out of control are convinced that sooner rather than later the Chinese government is going to have to allow the renminbi to appreciate.

The same official who offered that the People’s Bank would raise reserve requirements to 18% also said that this move put off any move on the Chinese currency until July. On the other hand, a former U.S. trade official with a name—Frank Lavin, former Under Secretary for International Trade at the U.S. Department of Commerce, told Bloomberg today that China “may” announce a change in the peg sometime in May in time for the visit of Treasury Secretary Timothy Geithner and Secretary of State Hillary Clinton to Beijing on May 24.

Tune in tomorrow for another episode in “When the renminbi turns.”

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