China’s central bank will be reluctant to launch a massive monetary stimulus despite the looming threat from the eurozone debt crisis, a former senior official has warned.

China’s former banking regulator, Liu Mingkang, told a conference on Friday that Chinese authorities were unlikely to pressure banks to boost their lending in order to cushion the world’s second largest economy from plunging global demand.

According to a report in the Chinese publication Caijing, Liu said Chinese authorities were unlikely to use “a sharp increase in money supply to cope with global financial crisis and Asia financial crisis, like we did before.”

His comments came just one day before China’s central bank, the People’s Bank of China, moved to cut reserve requirement ratio — the level of deposits that banks must hold in reserve. The 0.5 percentage point cut is expected to release about 400 billion yuan ($US63.5 billion) into the banking system that can be used for lending.

But analysts said that the cut in the reserve requirement ratio was a cautious response to the steep drop in bank lending last month, rather than a major monetary stimulus.

China’s banks made just 738.1 billion yuan ($US117 billion) in new loans in January, a drop of 29% from the same month a year earlier. At the same time, banks suffered from a massive 800 billion yuan outflow of deposits, as Chinese enterprises slashed the amount of money they held in low-interest rate deposits with the banks.

China’s central bank raised the reserve requirement six times last year, as it tried to mop up excess liquidity in the system. Now that deposits are leaving the system, the central bank has little choice but to relax the ratio. Indeed, many market watchers had expected that the reserve requirement ratio would be cut before the Chinese Lunar New Year. Instead, the central bank opted to use open market operations to ensure banks had enough short-term cash.

According to analysts, although Beijing has now begun to relax tight monetary policy, it is only doing so gradually. Chinese authorities appear particularly anxious to avoid a repeat of the lending binge that was launched following the global financial crisis, which fuelled a dangerous property market bubble, and left banks holding heavy exposures to risky infrastructure projects.

Beijing has had some success in cooling the property market last year, with land sales falling sharply, and real estate prices edging lower. China’s premier, Wen Jiabao, has repeatedly warned that Beijing will keep restrictive policies in place until prices have returned to reasonable levels.

At the same time, China’s central bank is keeping a close watch on inflation. China’s inflation rate jumped to 4.5% in January, although this was largely the result of higher food prices over the Lunar New Year holiday.

However, the bank will be keen to ensure that rising Chinese labour rates don’t feed into inflation. At the weekend, Foxconn Technology announced an immediate 16-25% boost in the salaries that workers are paid at its Chinese factories. Foxconn, which is one of the biggest manufacturers of products for Apple, Dell, Hewlett-Packard and other electronics companies, also said that it would reduce the amount of overtime worked.

Analysts warn that China’s central bank is likely to err on the side of caution ahead of the once-in-a-decade transition in the Chinese political leadership later this year. They argue that the central bank will be extremely concerned to ensure that the economy is in good shape when Beijing’s new leaders take control.

*This article was first published at Business Spectator

Peter Fray

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