Yuan gush

From Michael Pettis’s exclusive newsletter comes this update on Chinese lending and interest rates:

It seems that already bankers might be anticipating the relaxation of lending targets.  Rumors on the ground suggest that new lending in January may come in as high as RMB 1.2 trillion.  This might seem pretty strong evidence that the PBoC will be unable to keep credit growth this year to RMB 6.8 trillion – after all 17.8% of the total annual quota in the very first month sounds like a lot.

But January is always a crazy month for new lending, with banks rushing to expand their balance sheets as fast as they can.  January lending represented, for example, 16.4% of the 2008 quota, 16.7% of the 2009 quota, and 17.5% of the 2010 quota (or RMB 0.8, RMB 1.6, and RMB 1.4 trillions, respectively).  This January’s lending will be high relative to the quota, in other words, but not by a huge margin.  My SWS associate Long Chen, who follows the money markets closely, had this interesting comment over the weekend:

And third, groups with different interests within the Chinese government have restricted the PBoC’s power to control lending. Local governments, the NDRC and even central leaders want to see high growth, which is mainly generated by huge investments backed by loans. Furthermore, chairmen of big banks are very powerful as they all have vice-minister titles in the government. In addition to this, the CBRC and PBOC have differences of opinion, which make monetary policy even harder to execute.

The PBoC has injected liquidity into the market for the eleventh consecutive week through open market operations. This week the central bank stopped issuing bills and injected RMB 470 billion into the market with a RMB 300 billion reverse-repo on Monday night. However, money market rates rose to an even higher level as the 7-day repo rate remained above 8% for the whole week.

This should not have been a surprise, he says.  Last week he wrote that we would have to wait until after the holiday before we saw lower rates.  There were several factors that caused the current tightness. First, the most recent, unexpected minimum reserve requirement hike had an adverse impact on liquidity as banks scrambled to increase their holdings at the PBoC.

Second, rural workers usually withdraw a lot of cash from banks to bring home for the Chinese New Year, making banks reluctant to lend before the holidays. Third, there was lots of new paper issued in the markets, as we discussed last week, with many institutions wanting to borrow money to subscribe.

Finally, January CPI is widely expected to approach 6%, so banks want to hang on to liquidity as the market is anticipating a rate hike around Chinese New Year.  Chen Long goes on:

We believe banks have advanced RMB1.2 trillion in new lending so far in January, which far exceeds regulatory targets. This is not a surprise as banks typically try to lend as much as possible at the beginning of the year. Regulators have never successfully controlled this. There are at least three reasons why bank loans always exceed targets.

First, the lending rate is so low in China that it is impossible to control demand. With the 1-year lending rate at 5.81%, almost the same as CPI, and high growth, everybody wants to borrow. Second, there is a strong incentive for commercial banks to expand their balance sheets as quickly as possible – department heads who lend more get promoted faster.

Time to tighten?