China's Call to Cool Off Lending Gives Investors a Chill

Slow down! That's the message Chinese economic authorities are sending out loud and clear. For the second time since mid-January, the People's Bank of China, the nation's central bank, has raised reserve requirements for banks. Effective Feb. 25, the country's large banks will be required to increase their reserves to 16.5%, up a half-percentage point from the January level. Smaller banks will now have to keep 14.5% in reserve, also up a half-percentage point.The central bank apparently decided it needed to move the reserve requirement up yet again because record lending continued in China even after the January increase. China reported Thursday that lending in reached 1.4 trillion yuan ($200 billion), which is about 20% of 2010's planned total. China set that ceiling at 7.5 trillion yuan ($1.1 trillion), down from 9.5 trillion yuan in 2009.

Banks clearly haven't been listening to the government. While it's tradition in China for most lending to happen early in the year, Beijing wants to level out that throughout the year to avoid overheating the economy. But agricultural lenders were exempted from the increased reserve requirement to be sure agriculture gets adequate credit.

Where China Goes, the World Follows

China has been leading the world out of the greatest global recession since World War II, and markets have dropped since mid-January, when China first signaled strongly that it wants to wind down its stimulus. Chinese GDP expanded at a sizzling 10.7% in 2009's fourth quarter.. Even with that growth rate, China doesn't want to raise interest rates to control possible inflation and hurt the recovery. Instead, it's trying to get some control by raising bank reserve levels to slow lending.

The Chinese government's other big concern is the rise in housing costs. An index tracking 70 Chinese cities jumped 9.5% year-over year in January. That's a 1.3 percentage-point rise from December's growth rate. Land prices jumped 106% in 2009, according to Standard Chartered Bank.

After the January announcement increasing reserve requirements, banks promised to curtail lending. For example:
  • Industrial & Commercial Bank of China, China's biggest lender by assets, told its Beijing branches not to issue new loans for the rest of January;
  • China Citic Bank suspended new lending in Shanghai for those branches that had already used up their quotas;
  • Bank of China Ltd. stopped extending new corporate loans in Shanghai, except for clients that had already repaid previous loans;
  • And China Construction Bank told its branch in Shanghai to screen applications for personal loans and mortgages more carefully, and to stop new lending once a monthly quota is met.
But obviously the banks didn't tighten the strings enough. The Industrial & Commercial Bank of China said this week it will reject loans to real estate and industrial projects deemed too dirty, energy-intensive or unnecessary.

IPOs Take a Beating

While China is trying to get ahead of inflation and prevent asset-price bubbles with these moves to tighten lending, it's sending markets down and hurting initial public offerings, with several recent IPOs debuting below their offering price. And today, the Agricultural Bank of China said it wouldn't proceed with its IPO because of weak market conditions. The bank, which is China's third largest lender, is the only one of China's Big Four state-owned banks not publicly traded. The IPO would have been a dual listing in Shanghai and Hong Kong as early as April in a deal that could have raised as much as 122 billion yuan ($22 billion).

Qu Hongbin, chief China economist for HSBC Holdings applauded China's moves even though they're making global markets nervous. He told BusinessWeek that "timely tightening in China will help sustain growth and avoid overheating, benefiting the world in the long run." Lu Zhengwei, a Shanghai-based economist at Industrial Bank Co forecasts that China will raise the lending rate from 5.31% as early as April.

Clearly, China is trying to deflate its asset bubbles gently with these moves, but can it? It's up against some daunting odds because so far few countries have succeeded in that effort.
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