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Saturday February 21, 2009

Central bank policy shift a sign of China’s economic weakness


WHILE other central banks are pumping more money into their struggling economies, China’s central bank has started draining funds. But the policy shift is more a sign of China’s economic weakness than its strength.

The central bank appears to be trying to curb an unwelcome boom in companies’ short-term bill financing, which may be diverting money away from long-term investment in an economic recovery and storing up inflationary pressure for the future.

The bills debacle shows that while authorities can flood the economy with money, via monetary policy easing and a US$585bil stimulus plan, they are finding it harder to direct the money into areas where they want it.

“Some money generated by new lending is not flowing into the real economy,” said Yang Yongguang, fixed income strategist at Sealand Securities. “This is worrying for the central bank.”

China’s total yuan lending jumped 21.3% from a year earlier in January, after the central bank slashed interest rates late last year and the government pressured state-owned commercial banks to lend more to help the economy.

But fully 39% of new lending – up from an average 13% in 2008 – was discounted bill financing, in which banks trade corporate bills with tenors of up to six months.

That implied banks and firms, nervous about the economic outlook, were using a lot of funds created by monetary easing for unproductive financial engineering, not for the kind of long-term investment in economic growth that authorities want to see.

Firms put much of the money they raised via the bills market into higher-yielding bank deposits, analysts believe; M2 money supply growth, which includes savings deposits, accelerated last month while M1 money supply growth, which excludes them, tumbled.

This threatens inflation down the road without increasing economic activity today. Other funds may have gone into short-term speculation in the stock market, where turnover soared to near levels last seen during the equities bubble of 2007.

Zhang Jianhua, head of the central bank’s research department, appeared to have had discounted bill financing in mind when he warned on Thursday that further interest rate cuts could create a “liquidity trap”.

That is a situation in which money created by ultra-low rates fails to help the economy, as borrowers keep it in short-term bank accounts rather than making long-term investments.

“If we continue to cut interest rates, a liquidity trap could result. The money would not enter the real economy,” Zhang said in a speech to bankers in Shanghai.

The central bank has not issued a public warning against excessive bill financing, probably because that could alarm fragile financial markets. – Reuters

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