Central bank warns of inflation
(China Daily)
Updated: 2004-03-05 14:59

Inflation is the new economic trend policy-makers are focusing on, which differs from recent years when deflationary pressure was a major concern. Zhou Xiaochuan, governor of the People's Bank of China, said recently that the government should be wary of possible inflation.

In its 2003 monetary policy report published last week, the People's Bank of China (PBOC), the central bank, examined the monetary trends behind the nation's rapid economic growth last year, and offers its assessment for this year.

The following are excerpts from the report.

Overall, the relatively fast credit growth seen in the first half of 2003 was brought under effective control in the fourth quarter.

The renminbi exchange rate remained stable, and the performance of the financial sector was also generally stable.

Workers examine the first batch of molten iron from the furnace at Rizhao Iron and Steel Co Ltd in East China's Shandong Province. Investment in the industry suffered from overheating last year. [newsphoto]

Broad money M2 (which includes cash in circulation and all deposits) stood at 22.1 trillion yuan (US$2.66 trillion) at the end of 2003, up 19.6 per cent on an year-on-year basis. The pace was 2.8 percentage points faster than in the previous year.

Outstanding cash in circulation was 1.97 trillion yuan (US$237 billion), up 14.3 per cent on a year-on-year basis.

* Loans by financial institutions increased rapidly in the first three quarters, but the momentum was contained in the fourth quarter.

Outstanding renminbi and foreign currency loans by all financial institutions (including foreign banks operating in China) stood at 17 trillion yuan (US$2.05 trillion) at the end of 2003, 3 trillion yuan (US$360 billion) more than one year earlier.

* Renminbi deposits rose rapidly, while foreign currency deposits decreased.

The total of outstanding Chinese and foreign currency deposits was 22 trillion yuan (US$2.65 trillion) at the end of last year, an increase of 3.7 trillion yuan (US$445 billion) from the end of 2002. The increase was 835.1 billion yuan (US$100 billion) higher than in the previous year.

Foreign exchange deposits dipped by US$1.92 billion, which compared to an increase of US$10.7 billion one year earlier.

* Base money grew fast, while liquidity at financial institutions remained basically within normal boundaries.

Outstanding base money at the end of last year stood at 5.23 trillion yuan (US$630 billion), an annualized 16.7 per cent increase, 4.9 percentage points higher than the previous year.

The ratio of excess reserves by financial institutions stood at 5.38 per cent at the end of last year. The ratio was 4.12 per cent for State-owned commercial banks, 8.33 per cent for joint-stock commercial banks and 8.11 per cent for rural credit co-operatives.

* The aggregate level of interest rates and money market rates remained fundamentally stable.

The one-year deposit rate, at 1.98 per cent currently, has not changed since the rate cut on February 21, 2002 and is the lowest in 20 years.

* Official foreign exchange reserves continued to grow, while the exchange rate of renminbi remained stable.

China's foreign exchange reserves stood at US$403.2 billion at the end of 2003, up US$116.8 billion from the beginning of the year, the largest annual increase.

The renminbi's exchange rate remained stable, quoted at 8.2767 per US$1 at the end of the year.

Financial markets

* Interbank turnover rose rapidly.

The activity of interbank trading hovered at high levels in 2003, with fast-increasing turnover. Total turnover was reported at 2.4 trillion yuan (US$289 billion), up 1.2 trillion yuan (US$145 billion), or 99.2 per cent, from the previous year.

* Bond issuance was generally healthy with trading being active.

The Ministry of Finance issued a total of 628 billion yuan (US$76 billion) in treasury bonds, up 35.1 billion yuan (US$4.2 billion) or 5.9 per cent on a year-on-year basis.

Policy banks floated 452 billion yuan (US$55 billion) in financial bonds (excluding a five-year US$500 million dollar-denominated issue in September, 2003), a 47 per cent increase from the previous year.

Corporate bond issuance totalled 144.5 billion yuan (US$17.4 billion), up 3.3 billion yuan (US$397 million), or 10.2 per cent, from the previous year.

Trading in the interbank bond market was active last year. Turnover hit a historic high of 14.8 trillion yuan (US$1.78 trillion), up 39.3 per cent on a year-on-year basis. Liquidity in the market improved noticeably.

* The commercial bill market grew along a regulated path.

In 2003, businesses issued commercial bills worth 2.77 trillion yuan (US$333 billion), up 72.2 per cent from 2002. The volume of discounting and rediscounting jumped by 91 per cent to 4.44 trillion yuan (US$534 billion).

* The stock market operated in a stable manner.

Total turnover was 3.21 trillion yuan (US$386 billion) in 2003, an increase of 410 billion yuan (US$49 billion) from 2002.

Substantially more funds were raised through the market. Total stock financing rose by 41.1 per cent year-on-year to 135.7 billion (US$16.3 billion), led by H shares and convertible bonds.

* The insurance market developed rapidly.

The number of insurance companies grew to 56 before the end of 2003, while their total assets continued on a fast growth path, jumping by an annualized 41.5 per cent to 912.3 billion yuan (US$109 billion).

Premiums totalled 388 billion yuan (US$46.7 billion) last year, up 27.1 per cent on a year-on-year basis.

* Foreign exchange transactions increased noticeably.

Due to rapid foreign trade growth, broadening US dollar interest rate differentials between domestic and foreign markets, as well as the spread between renminbi and dollar deposits, turnover in the interbank foreign exchange market rose significantly last year.

Turnover in all foreign currencies traded stood at US$151.1 billion, up US$53.9 billion from 2002, of which US dollar transactions totalled US$147.8 billion, up 54.2 per cent.

Macroeconomic analysis

In 2003, the Chinese economy overcame difficulties, like the SARS outbreak, and came to a healthy period of accelerated growth, improved profitability and greater vitality.

But problems, which threaten to undermine sustained and healthy economic growth, have emerged some industries have been found to have blind investments, transportation and power sectors are under "bottleneck" constraints unseen in years, and growing inflationary pressure.

* The Chinese economy is on the upward curve of its economic cycle, with fast growth in investment demand being the major driving force.

Economic growth in 2003 was the fastest since 1997. Quarterly growth came in at 9.9, 6.7, 9.1 and 10.7 per cent respectively.

In the three major pillars of demand consumption, investment and exports investment witnessed the fastest growth in 2003, only slower than in 1992 and 1993, when the economy was overheating.

The nominal growth of fixed asset investment was 26.7 per cent last year, with actual growth at around 24.5 per cent. On a monthly basis, the pace peaked at 32.8 per cent in June, but subsided month-by-month afterwards following policy adjustments.

Investments in real estate development grew by 29.7 per cent in 2003, the fastest since 1995.

In April and May, consumption reversed its usually stable growth curve to dip abruptly when SARS came. The annualized growth of retail sales was only 4.3 per cent in May, half the pace from a year earlier and the lowest since 1991.

But spending recovered quickly after the SARS outbreak, returning to normal levels in the third quarter. Full-year growth of retail sales ended at 9.1 per cent, up 0.3 per cent from the previous year.

Both exports and imports increased rapidly, but trade surplus shrank, reducing the contribution of net exports to economic growth.

* Inflationary pressures heightened, calling for closer attention.

The consumer price index (CPI), on an annualized basis, kept on a moderate growth path in the first eight months of 2003, but started to accelerate in September, hitting 3.2 per cent in December. Even if prices do not rise further this year, the full-year growth of the CPI will reach 2.2 per cent.

Growth in the key gross domestic product (GDP) index that measures the full picture of inflationary pressures amounted to 4.5 per cent in 2003, compared to 0.8 per cent in 2000, zero in 2001, and a negative 1.2 per cent in 2002.

That indicates that it is difficult to be optimistic about the outlook for inflation.

* Some industries expanded capacity blindly.

In 2003, some industries, especially steel, aluminum and cement, undertook rapid capacity expansion and duplicate construction.

Output of steel, aluminum and cement rose by 23.3, 26.1 and 16.5 per cent respectively, currently making China the biggest producer of all three products.

The general capacity in these sectors has surpassed the expected market demand. The product structure is improper, and problems of high energy consumption, high pollution and inferior quality have become very serious.

Forecast and outlook

We estimate that the CPI this year will grow by around 3 per cent, with 2.2 percentage points coming from annualized adjustments and around 1 percentage point being driven by new price hikes and policy-based price changes.

In addition, there are upward price pressures that are difficult to quantify.

First, the rapid growth of the economy and investments this year will push prices up further.

Second, the lagged effect of price hikes on food in 2003 will come into play gradually, fuelling price hikes in downstream products and raising aggregate price levels.

Then, there is the lagged effect of last year's fast monetary growth.

There are also downward price pressures mainly the downtrend in auto, home appliances and chemical prices.

Overall, upward pressures on prices in 2004 outweigh downward pressures.

* Monetary policy inclinations for 2004

The bank will, while promoting stable and relatively fast economic growth, pay great attention to preventing inflation and financial risks.

Taking into account the lagged effect of 2003's fast credit growth, the growth in money supply and new loans this year should be lower than levels seen in 2003. Our estimate is M2 and M1 (cash in circulation and demand deposits) will both grow by around 17 per cent, while renminbi loans will increase by 2.6 trillion yuan (US$313 billion).

1. Improve planning in monetary policymaking, and maintain stable growth in aggregate lending.

In light of the problems in the economy, the PBOC will continue to contain the aggregate level of credit by using various monetary policy tools.

We will strive to both prevent excessive credit growth and guarantee funding needs for stable economic growth, in order to ensure the economy's stable performance.

The bank will continue to enhance analysis on macroeconomic conditions and adjust market liquidity when appropriate by ways such as central bank bills and open market operations.

We will step up relending and rediscounting management and improve the co-ordination among various monetary policy tools to maintain appropriate growth in base money.

2. Propel market-oriented interest rate reform in a steady manner, and promote the role of interest rates in macroeconomic management.

Considering the domestic and international economic and financial conditions, it is appropriate to maintain the basic stability in renminbi lending and deposit rates at present, and steadily promote market-oriented reform of the interest rate regime.

3. Maintain the fundamental stability of the renminbi's exchange rate at an appropriate and equilibrium level.

The bank will, under the precondition of effective risk prevention, loosen restrictions on cross-border capital transactions on a selective and gradual basis, and promote the (renminbi's) capital account convertibility.

4. Strive to adjust the loan structure and promote the optimization of the industrial structure.

The bank will enhance monitoring of credit performance and gradually establish a credit risk warning system for key sectors like steel, auto, power and real estate as well as basic industries.

It will guide commercial banks towards improving the lending structure and tightening risk management on projects in sectors with blind investments and low-level duplicate construction.

It will also encourage commercial banks to step up funding support to agriculture, small- and medium-sized enterprises, education, consumption and increase lending that helps create new jobs.

5. Accelerate the development of financial markets, and promote direct financing.

The bank will continue to support the reform, opening up and stable development of the capital market, broaden the channel for direct financing to change the unreasonable financing structure featuring an excessively low proportion of direct financing, and establish a unified securities market.

6. Accelerate the joint-stock restructuring of State-owned commercial banks, and provide funding assistance to the reform of rural credit co-operatives.

The comprehensive reform of State-owned commercial banks is a key part of financial reform. Much focus is placed on linking recapitalization to deepening the banks' internal reforms and improving their corporate governance structure.

The bank will work closely with the China Banking Regulatory Commission and other departments to, under the principle of equal importance on reform and regulation, strictly supervise the implementation of reform measures by the pilot banks and ensure the fulfillment of all the goals of the joint-stock reform.