Analysis: China needs new policy course as capital tide turns

Wed Dec 28, 2011 1:13am EST
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By Kevin Yao

BEIJING (Reuters) - China's economy has surfed for years on a crest of hefty capital inflows, but the tide that brought gains in money supply is turning as global growth slows.

Capital has flowed out the past two months. If that persists, the challenge for the People's Bank of China will be to adjust policies to keep the country's growth rates from falling much.

That will be no mean feat for policymakers schooled in absorbing inflows averaging 256 billion yuan ($40.5 billion) a month since July 2005, but short on experience of how to handle outflows.

"I think this indicates a significant change in the environment for monetary policy -- from large 'twin surpluses' to a more balanced external position," Hua Zhongwei, an economist at Huachuang Securities in Beijing, told Reuters.

"So the situation under which the central bank 'passively' releases liquidity into the economy will change. It may have to pump out money in a pro-active way," he said.

The most likely way that pump will operate is through a simple reversal of the increases in the amount of cash commercial banks are required to keep as reserves -- the same tool that was used to drain the excess liquidity created by capital inflows.

The 600 basis points of required reserve ratio (RRR) hikes between January 2010 and June 2011 to a record level of 21.5 percent drained some 4 trillion yuan from China's economy.

That was as the central bank fought to bring money supply growth down from a breakneck -- and dangerously inflationary --pace close to 30 percent in late 2009, to a level closer to the 12-14 percent that international economists believe China targets.   Continued...