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LAST WORD: Raising the Reserve Requirement Ratio
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altTurning round “the ship of state” is a very difficult task. Like a ship, countries and economies have enormous momentum behind them, in the form of trading relationships, business practices, and economic structures and agreements, and to alter these takes considerable time. Economies aren’t just numbers; they are aggregates of human efforts, of labour. It always comes down to people, and altering behaviours is a difficult process. Similarly, the markets like to have a sense of financial trajectory, a sense of where the economy is headed, a sense of where sound investments can be found. - It’s when markets are faced with uncertainty, as with the ongoing euro-area financial situation, that squeals of protest come through. Predicting the future is often a silly pastime, and it’s the easiest thing in the world to look at anticipations of the future which turn out to be erroneous, but governments do best when they articulate their economic frameworks clearly and confidently, and follow up with decisive action.

The Chinese framework until recently has been clear. The CNY has been appreciating at around 0.5% per month. The reserve requirement ratio (the proportion of a bank’s capital kept in reserve, in case of credit crunches or other problems) has been steadily rising to reduce liquidity. Supply-side restrictions on property ownership, such as requiring a 50% down payment on a second apartment, have been increased. These moves were designed to cool the property sector, and to gently encourage a move towards domestic consumption and away from export manufacturing. These moves followed the Chinese custom of incremental reform, and with their pragmatic rationale seemed to have the approval of the markets.

However, events in the Chinese economy have been moving faster. Signs of distress in the housing market emerged during autumn, with developers beginning to offer sometimes large discounts to encourage buyers, who were starting to disappear. With developers highly leveraged, they needed to sustain sales to maintain cash flow, but with sales volumes down considerably, (Business China cited a 57% drop in Tianjin’s November transactions, year-on-year), cost-cutting was the only way. Prices though were plunging faster than many would have liked: the Shanghai showroom which offered 25% discounts was ransacked by those who had paid full price less than a month previously. This, though, isn’t the major problem it would be in western economies (as we’ve seen from the troubles in the US and the UK). China has a far less developed secondary market (the market for previously-owned properties), and owners are generally much less leveraged, tending to pay large deposits or buying outright in cash. Most property owners assume that the government will ensure that prices do not drop too far, and without anywhere to invest except in stocks and property, it’s likely that there is a reserve of would-be owners waiting for prices to fall.

But such rapid falls in prices, along with the endless troubles of the euro area which are depressing the European economy and their appetite for imports from China, evidently caused concern at the People’s Bank of China (PBOC), despite Premier Wen Jiabao’s repeated statements that the government intended to curb rampant housing inflation. On 30 November, the bank reduced the reserve requirement ratio for the first time since 2008, cutting it by 50 basis points from a record high of 21.5%, thus adding CNY 400 bln of liquidity to the Chinese economy by freeing up capital for new loans.

altThis marked a clear change in China’s tightening policy and was concurrent with similar actions from the euro zone, Brazil, Indonesia and Thailand. Given the rise in unemployment and the dispersal of low-cost manufacturing to cheaper countries like Laos and Vietnam, this may be a good idea. But on the other hand, it seems to indicate the unwillingness of the Chinese governing class to alter the current economic system without suffering the birthing pains of a new approach. If the role of a central bank is to remove the punch bowl before the party really gets going (a phrase attributed to William McChesney Martin, Jr., a former chairman of the Federal Reserve), then the Chinese economy has just been handed another round. The Chinese economic dependence on property is well-known (a recent poll of Chinese with between USD 78,520 and USD 157,000 in investments revealed that property made up 75% of the their assets), yet the day of reckoning is always postponed.

A parallel might be the British experience of the early 1980s. Under the premiership of Margaret Thatcher, the British government greatly reduced the size of the state sector, cut the power of trade unions, and let the pound float freely. The aim was to change the British economy from being over-manned and subsidy-dependent to one which was far leaner and meaner. This was done, but at some considerable cost: unemployment more than doubled by 1983, and some areas of the UK, like the north of England and the greater Glasgow area, have never recovered. Even now, Thatcher’s name is a curse in parts of the UK. Yet the UK economy, despite recent problems, did reform, with considerable gains in productivity.

What the Chinese economy needs to do is well known. Whether it can be managed is another thing. We shall simply have to wait and see.

By Mike Cormack

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