Source: TheEdge, UOBAM and Fullerton Fund Management

Last Tuesday, the People’s Bank of China (PBOC) announced it will raise the reserve ratio requirement (RRR) by 50 bps to 16% from 15.5% for big banks and to 14% from 13.5% for smaller institutions from Jan 18 with rural credit cooperatives excluded. The PBOC also raised rates in the interbank market for the second time within a week.

As a result, the Hang Seng Index lost 578 points or 2.6% to close at 21,748 on Wednesday while the Shanghai Composite Index dived 3.1% or 101 points to close at 3,172.

This is the first time since Dec 08 (after the Lehman collapse) that the PBOC is raising the ratio. Analysts and economists were expecting the RRR to be raised sometime in February. According to Bloomberg News, a median of 11 forecasts were expecting the move to be made only in April.
Tightening was expected because China’s economy has been rebounding strongly, with real GDP growth in the third quarter of 2009 up by 8.9% and inflation turning positive in November. In UOBAM’s view, more hikes in the RRR are likely to follow in the coming months but the Chinese authorities are not likely to embark on any aggressive tightening of credit as the global economy is still weak and China needs domestic demand to stay strong. What we are seeing is possibly a normalisation of monetary policy, to return liquidity conditions back to pre-Lehman levels.

In a research note, DBS Research says that the China’s decision to hike its RRR “sends the clearest signal yet that it is beginning to tighten monetary policy”. While the 0.5 percentage point increase in bank reserve requirement only drains about RMB200-300 billion ($40.7–$61.1 billion) from the market, it could be the start of further tightening which could drain another RMB500 billion from the market. Moreover, this first step comes in the wake of the Chinese government’s concerns over inflation. Bank lending is estimated to have risen to RMB600 billion in the first week of January versus RMB295 billion in Nov ’09. Asian markets could be vulnerable should PBOC tighten further.

Recent approval of index futures trading, margin trading and short selling is a significant milestone in the development of China’s capital markets. These will provide investors to hedge their risks and may narrow the trading gap between China and Hong Kong stocks.

About the Author

Ivan Guan is the author of the popular book "FIRE Your Retirement". He is an independent financial adviser with more than a decade of knowledge and experience in providing financial advisory services to both individuals and businesses. He specializes in investment planning and portfolio management for early retirement. His blog provides practical financial tips, strategies and resources to help people achieve financial freedom. Follow his Telegram Channel to join the FIRE community.
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