By Yi Xianrong (China Daily)
Updated: 2007-12-13 10:24

At the nation's Central Economic Work Conference held last week, the authorities decided to change the "prudent" monetary policy, enforced for nearly a decade, to a "tighter" one, indicating a major change in policy next year.

Starting from 2003, bank loans were on a steep rise, especially this year.

The commercial banks lent 1.42 trillion yuan ($1.86 billion) in new loans in the first three months of this year. The new loans totaled 2.5 trillion yuan by the end of June and 3.36 trillion yuan by the end of September.

The banks granted 3.58 trillion yuan in new loans in the first 11 months of this year, compared with 3.18 trillion yuan for all of 2006, according to a report released on Monday by the People's Bank of China.

Many commercial banks have exceeded the anticipated loans target for the whole year in the first nine months despite the central bank raising the reserve requirement ratio for commercial banks 10 times and lifting interest rates five times this year.

The bank loans have created high liquidity in the capital market, pushing up the prices of securities and property.

In the third quarter, average property prices in 70 big and middle-sized cities across the country rose by 8.2 percent over the same period last year. Prices were up by 13.5 percent in Beijing and by 17.6 percent in Shenzhen.

The increase also triggered more bank loans for real estate investment. By the end of September, bank loans for commercial estates totaled 4.62 trillion yuan, 1.76 trillion of which was lent to estate developers and 2.86 trillion to mortgage borrowers.

Worse, the China Banking Regulatory Commission, the country's banking watchdog, found in a recent study that a considerable amount of bank loans were involved in fake or deceptive property deals.

Some estate developers and investors had altered contracts to make them acceptable under the laws and regulations pertaining to mortgages. These loans were often in speculative property deals, posing a big risk to the banks.

It has been proved in the subprime crisis sweeping the United States that bank loans, if they grow too fast, not only cause estate bubbles, but also pose risks to banks.

Excessive liquidity has also played a major role in the price hikes of consumer goods this year. The consumer price index (CPI) jumped by 6.9 percent year on year in November, the highest level in 11 years, putting pressure on the authorities to curb inflation expectation in 2008.

And as prices for various commodities on the international market keep on increasing, it makes more difficult to bring down domestic prices.

Because of the CPI's continuous rise, the actual interest rate, or the inflation-adjusted interest rate, has been kept negative. It was 2.82 percent under zero in October after several rounds of interest rate hikes.

The negative actual interest rate distorts the pricing scheme in the financial market, destroys the fair distribution of social wealth and changes the anticipation of market players, all of which could affect the soundness of the economy.

The combination of all the above factors could lead to a more aggressive monetary policy next year.

It is expected that the central government will try to tighten the policy through market-orientated means instead of administrative ones.

This market-orientated policy could include more adjustments to banks' deposit reserve requirement ratio, open market operations, and central bank bills. The growth of bank loans could be curbed once again after being lifted for some years.

Interest rates, however, could be a more efficient and most frequently used tool next year.

To maintain price levels, the central bank may try to bring the actual interest rate above zero, so it will have to increase the current interest rate by about 2 percentage points if the CPI growth remains at the current level.

When the monetary policy is tightened, the property market will feel its impact.

As a capital-intensive sector, the property market relies heavily on bank loans and its increased activity is a direct result of the financial support from the banks.

Property investors will also feel the impact of the tightening policy for most of them also need bank loans as leverage to gain profits.

The property market could see a change after the money supply from banks is reduced. They could be weaker demand for property, a reduction in prices, a shrinkage in industries related to the property sector, a decrease in fixed asset investments, and less inflation pressure.

Thus, the tightened monetary policy might serve as a new way to further develop China's economy and maintain sustainability.


The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.