Forget Password?
  1. Indices
  2. Commodities
  3. Currencies
Straits Times 3,126.14 -8.57 -0.27%
Hang Seng 26,848.49 +184.21 +0.69%
Dow Jones 27,029.87 +27.89 +0.10%
Shanghai Composite 2,977.33 -1.38 -0.05%
Rising Interest Rate Not A Damper To China’s Growth
Malaysia Perspective | 02 August 2011

By Yeoh Mei Kei

Recently, China released various important economic data, with the most striking one being the new loans and inflation data.

Let us discuss about the new loans data first. The People’s Bank of China (PBOC) has continued to successfully tighten the monetary policy over the past 6 months, evidenced by the 551.6 billion Yuan increase in May new loans. This was lower than the target of 650 billion Yuan and it’s also 100.5 billion Yuan lower compared to the same period last year. In addition, the year-on-year growth rate of M2 money supply has dropped from 15.3% in March to 15.1% in May, which was lower than the estimated 15.5%. Both new loans and M2 money supply grew slower than expected, suggesting that the central government remains unchanged in tightening its monetary policy.

China’s year-on-year inflation surged to 5.5% in May. Inflation for non-food items recorded a monthly increase, reflecting that inflationary pressure has begun to spread from food items to other core items in the CPI basket. As the inflation issue remains unsolved, PBOC announced further increase in the required reserve ratio of banks on the same day it released the new loans data. This marks the 6th time that China has raised its required reserve ratio this year. Nevertheless, this is not surprising, as we have mentioned earlier that the central bank may utilise required reserve ratio as one of the tools to control inflation, while the hike in interest rates will be mainly intended to mitigate the problem of negative real interest rates.

There is no doubt that interest rates will eventually be hiked. However, we believe that the hike in interest rates is not intended to be used as a tool to control the inflation. Rather, it is to prevent persistent negative real interest rates, which could result in social instability and unrest if it continues for a long period of time.

How will Chinese banks be affected, although the increase in required reserves ratio was within our expectations? To answer this question, let us analyse the prospects for Chinese banks. Required reserves ratio is the percentage of liquid assets that the central bank mandates a bank to keep at all time. A higher required reserves ratio means bank’s loan-to-deposit ratio will be lower. Thus, required reserves ratio is actually an important monetary tool that the central bank can use in order to control money supply in the banking system.

The required reserves ratio of large to medium financial institutions reached a record high of 21.5% after the recent hike. However, we believe that the impact of recent hikes in required reserves ratio to Chinese banks would be minimal. As shown in the chart, the average loan-to-deposit ratio of Chinese banks is only about 70.1%, which means that un-loaned amounts that remain in the Chinese banks are around 30%. Thus, Chinese banks might not face immediate credit squeeze problems even if the China Banking Regulatory Commission increases the bank’s required reserves ratio to 25%. We believe that the net interest income of Chinese banks will not suffer much negative impact from the hike in required reserves ratio. On the contrary, they could likely benefit from widening net interest margins as a result of the increase in interest rates.

On top of that, the estimated price-to-book ratio for the Chinese banks in 2011 is only 2 times, while estimated return on equity ratio is as high as 20%. This, coupled with stable financial performance and foreseeable profitability (market consensus for 2011 is estimated to be 20%) has led us to believe that the Chinese banking sector would outperform the Chinese equity market in the 2H 2011. As the banking sector accounts for more than 40% of the Hang Seng Mainland Composite 100 Index, we thus remain positive on Chinese equity markets in 2H 2011.

Yeoh Mei Kei is a Research Analyst at

Join The Conversation
The Shares Investment editorial team welcomes constructive feedback on our coverage and content. We would also be delighted to answer any questions on the above article. Leave us a comment below, and we'll get back to you shortly!

All Rights Reserved. Pioneers & Leaders (Publishers) Pte Ltd. Best viewed with Mozilla Firefox 3.5 and above.