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UPDATED: August 17, 2009 NO. 33 AUGUST 20, 2009
No-Win Credit Situation
Credit may be the factor that exerts the most influence on the Chinese economy in the next year
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The People's Bank of China, the central bank, published a report on the execution of monetary policy in the second quarter, saying there are many difficulties and challenges confronting the Chinese economy. Lu Zhengwei, a senior economist at Industrial Bank Co. Ltd., examined the report and pointed out the excessive bank lending in the first half of this year may give rise to serious loan problems. He shared his view in the China Securities Journal. Edited excerpts follow:

Credit may be the factor that exerts the most influence on the Chinese economy in the next year.

I think it is totally necessary and urgent that the central bank pays attention to the credit problem. It might be the most influential factor dampening the economic recovery in the coming year, as either tightening or loosening credit will hurt the economy. If outstanding loans in the next year stand as high as those from this year, inflation will gain momentum and spiral out of control at the end of 2010. On the other hand, if the banks tighten credit controls, many projects that are to commence this year could be abandoned as construction might stop due to a lack of financial backing.

Either way, the banks may find themselves in a tricky corner in the near future. The credit expanding or withering will pose a significant challenge to the national economy nonetheless. As a matter of fact, the capital adequacy has become a major challenge for banks in light of stricter management and supervision. Such massive credit expansion—of up to 7.37 trillion yuan ($1.1 trillion) in the first half of this year—is unsustainable in 2010, unless banks issue more shares to investors to increase their cash flow.

Even though the central bank has repeatedly reassured investors that it will adhere to moderately loose monetary policy throughout the year, I believe there is an irreversible trend to rein in rampant credit and liquidity expansion. Speculators should not hope for another lending craze in the banking system in the second half of this year.

The world economy is currently recovering at a quicker-than-expected speed, making it possible to end the current loose monetary policy ahead of time. But the timing depends on when the U.S. Troubled Asset Relief Program exits from the market. Before the U.S. economy is fully rejuvenated, China will not take major moves to squeeze market liquidity, such as raising the reserve requirement ratio or hiking interest rates.

From my point of view, the U.S. Government will stop its aide to troubled companies once the GDP growth rate turns positive and when unemployment subsides. But it is still too soon to tell when this will happen.

The central bank report said it will adjust its policy "in line with the domestic and international economic trend and price fluctuations," which is a clear indication that the central bank will squeeze out liquidity whenever it thinks is necessary.

Therefore, if the Chinese and U.S. economic recovery is in sight, China will start raising interest rates in the third quarter of 2010 at the earliest.



 
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