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China adopts prudent monetary policy

Dec 03 2010 10:40 Reuters

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Beijing - China will switch to a prudent monetary policy from a moderately loose stance, the Communist Party's top leaders decided on Friday, a change that could pave the way for more interest rate increases and lending controls.

At the same time, the Politburo elected to maintain China's proactive fiscal policy, an indication that the government wants to continue to ramp up investment spending even while taking tightening steps to control inflation.

Chinese and global markets were little affected, with investors taking the view that the new wording was an affirmation of the gradual tightening that Beijing has already started to implement in recent months.

But while the change in description of policy had been discussed for several weeks by central bank advisers, the Politburo's endorsement, reported by the official Xinhua news agency, could still mark a decisive turning point.

"It means that all sort of monetary policy tools to control liquidity and to control inflation can now be used," said Ken Peng, an economist with Citigroup in Beijing.

"In the past we've been clearly focusing on administrative measures. Going forward we could be using more price adjustments via interest rates," he said, adding that he expected five rate increases by the end of next year.

China has raised interest rates just once this year as it has guided its monetary policy back to normal from the ultra-loose settings it adopted to counter the global financial crisis. Instead, it has used quantitative tools to do the heavy work, officially raising banks' reserve requirements five times.

Expression of confidence

Along with playing a role in the fight against inflation, policy tightening also signals confidence that the world's second-largest economy is on solid ground, even as the US and European recoveries remain fragile.

"China has no need now to worry about overall demand at all," said Dong Xian'an, chief economist with Industrial Securities in Beijing.

"Instead, the top priority is to curb inflation and avoid economic overheating."

"The sooner China acts and the more forceful measures it takes, the better," he said.

Consumer price inflation hit a 25-month high in October of 4.4% and is expected to have edged higher in November. Although it has been driven almost exclusively by food prices, pressures have been broadening on the back of higher global commodity costs.

China's cabinet vowed last month to take "forceful" measures, including price controls if necessary, to rein in inflation.

A major prong of the government's stimulus programme, was a flood of lending by banks. China has already begun to rein in loan issuance this year and the shift to a prudent monetary policy could signal more restrictions next year.

Wang Han, economist with advisory firm CEBM in Shanghai, said a prudent policy could imply a new lending target of 6.5 trillion yuan, down about 15% from this year's total.
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