China’s lending quota?

By Michael Pettis

This year to everyone’s surprise the PBoC failed to announce 2011’s lending quota. Instead it announced a series of new polices aimed at monitoring the banks. According to an article in Thursday’s People’s Daily:

The People’s Bank of China (PBOC), the country’s central bank, will check credit and capital levels of commercial banks each month to determine the reserve requirements for individual lenders, viewed as a measure to strengthen control over banks’ monthly credit.

The China Securities Journal reported on Wednesday that banks may have to set aside more reserves if their capital-adequacy ratios cannot meet the government-set standards, citing an anonymous source close to the People’s Bank of China.

“The key point of the differentiated reserve requirements lies in how important the individual financial institution is to the overall economy. Apart from systematic importance, its capital adequacy rate, operational stability and other factors will also be taken into account,” the source said.

There is a lot of debate about what all this means. In part, of course, it is aimed at the CBRC, with whom the PBoC has been rumored to be conducting a so-far losing turf battle over control of the banking system. By putting into place a complex monitoring system, then, the PBoC may be trying to reclaim priority in setting commercial bank policy and to keep the banks from gaming the system.

But would I have taken seriously a quota on new lending? Not really. It seems to me that if Beijing wants GDP growth in 2011 to come in at the expected 9%, the amount of new investment in China – which is determined in large part by the banking system – is really not something they can decide today. It is going to be whatever it needs to be given developments in household consumption growth and the trade surplus.

This is why I argued a few weeks ago that at whatever level the new loan quota was set, I was not going to think of it as constraining new lending in any way. Either the loan quota would be adjusted (upwards, almost inevitably) or more new lending would occur outside the banks’ balance sheets, as it did in 2009 and 2010.

Investment this year I suspect is going to be extremely high, as high as in 2009 and 2010, because it is only with very high levels of investment that we are likely to manage GDP growth rates high enough to keep Beijing happy.

So my guess is that 2011 will be yet another year in this increasingly strained investment-driven party. Chinese GDP growth will continue to be the envy of the world, while those of us who worry about the sustainability and quality of the growth will worry more than ever. The banks will probably rush to expand lending in the first quarter, out of fear that they may be restricted later in the year. And of course we will all be watching the trade account very closely.

On the topic of trade I am going to put on my broken-record hat and say what I have been saying for two years. Forget about momentary thaws, feel-good speeches, and pious posturing. The global trade environment is not about to get better. All of the distortions and strains remain, and the crisis in Europe is putting more pressure than ever on a resolution.

Why am I such a pessimist? Well let me limit my response by citing articles in just one newspaper last week.

On Tuesday, the Financial Times reported that the central bank of Chile, a country not known for its currency intervention, was going to force down the value of the peso to protect is external account:

Chile is set to become the latest country to join the “global currency wars” on Tuesday after the central bank said it would spend up to $12bn this year to curb the peso’s strength and so help exporters from one of Latin America’s most open and best managed economies.

…Felipe Larraín, Chile’s finance minister, said: “We are supporting domestic producers, our exporters, in the farm as well as industrial sectors who depend on exchange rates. We think it is a well targeted step that is going to have an effect on the exchange rate.

On Thursday it was Brazil’s turn, again, to intervene. The FT article reports:

Brazil’s currency, the real, weakened for the third consecutive day against the dollar on Thursday after the central bank announced curbs on short selling. The measures, aimed at halting the real’s further appreciation, give teeth to threats from the new government of President Dilma Rousseff that Brazil will act to protect the competitiveness of its domestic industrial base from exchange rate fluctuations.

Meanwhile on the same day the Financial Times reports that the IMF is getting very worried:

The International Monetary Fund has called for global guidelines on managing international capital flows, a sign of rising tensions as governments impose blocks on cross-border movements of speculative money.

…“In the aftermath of the global crisis, and especially now with resurgent capital flows requiring a considered policy response, it is not tenable for the fund to remain on the sidelines of a debate so central to global economic stability,” the report concluded.

On Saturday the Financial Times wrote about the dilemma that other countries, especially developing countries, are forced into because of Chinese currency policies:

China is not making life easy for anyone. In just a week the renminbi has given back 17 per cent of its rise since June, when Beijing loosened controls. It is now just 2.9 per cent stronger than in the summer and going in the wrong direction.

A weakening Chinese currency is one of the few things that could unite Republicans and Democrats in Washington. It is also sure to worry those faced with the increasingly difficult task of managing other emerging economies, for whom China is the main competitor.

The global story, in other words, is pretty consistent. Every country is attempting to gain a larger share of weak global demand, or at least to protect its share against predatory tactics elsewhere. Countries that can intervene in their currencies will do so – many of them nonetheless insisting that while their own currency intervention is not harmful to the rest of the world, currency intervention by other countries is harmful to them.

Countries that cannot easily intervene in the currency – mainly the US and Europe – are faced with a very difficult prospect. Either they must give up the hope to rebuild growth and employment based less on consumption, and more on production and manufacturing, or they must do “something else”. What else can they do?

Europe is doing something, albeit very unwillingly. On Friday the Financial Times warned yet again about Portugal:

Portuguese equities and bonds tumbled on Friday, forcing the European Central Bank to intervene to steady the markets as investor fears rose about the ability of Lisbon to fund its public debt. Portugal’s cost of borrowing, or bond yields, jumped to euro-era highs while some of the country’s banking stocks slumped to 17-year lows amid hardening views in the markets that Lisbon will have to follow Greece and Ireland into using bail-out loans.

The rest of Europe doesn’t look a whole lot better. That same day the Financial Times reported:

Eurozone unemployment remained at record levels in November, dashing hopes that Europe’s nascent economic recovery would filter down quickly to its labour market. The jobless rate in the 16 countries then using the euro was stable at 10.1 per cent, the highest level since the creation of the single currency in 1999, according to Eurostat, the European Union’s statistical arm. It also unexpectedly downgraded estimates of the bloc’s economic output for the third quarter of 2010, from 0.4 per cent to 0.3 per cent.

So peripheral Europe is resolving its external imbalances more or less by a collapse in net demand. With high and rising unemployment, and an increasingly difficult refinancing environment, we can pretty much expect European deficits to disappear, even while European surpluses (mainly German) surge on the back of the weak euro and fiscal tightening.

So that leaves the US. Either it can accept rising trade deficits as it absorbs the employment problems of the rest of the world, or it can move to intervene in trade. I don’t know what it will do, but I am pretty confident that the domestic debate will intensify. One way or the other the crisis in international trade is far from over. In fact the day after I finished this entry the Financial Times, again, had a new headline: “Trade war looming, warns Brazil.”

This is an abbreviated version of the newsletter that went out Monday. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at [email protected], stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities (HK) will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me at that address.

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