With China once again facing the prospect of an overheating economy many analysts have begun to speculate on when the authorities will raise interest rates. But this fixation on the arcane kabuki of Chinese monetary policy is a mistake.
For one thing, Chinese financial institutions are virtually all state-owned and so the People’s Bank of China (PBoC) doesn’t need to raise benchmark interest rates to affect their behaviour – it can just order the heads of the major institutions to change their behaviour.
And that is exactly what it does.
The PBoC and banking regulators regularly call in China’s largest banks and tell them to increase or decrease lending or concentrate their services in certain sectors or regions, depending on the economic and political imperative of the time.
Ready, set, lend
When the financial crisis threatened to engulf China’s economy in the final months of 2008, Beijing ordered the banks to open the spigots and drown the nation in liquidity.
What turned out to be the biggest financial and monetary easing in the history of any economy ever (according to Goldman Sachs economist Jim O’Neill) was referred to throughout by the Chinese government as a "moderately loose monetary policy." If that was moderation I’d hate to see what Chinese "quantitative easing" looks like.
What was in fact an ultra-loose monetary regime led to a doubling in new loans last year and a 30% rise in the total stock of outstanding bank debt. It also terrified regulators enough for them to quietly ask the banks to start modifying their lending in the second half of last year.
Lending fell to slightly more reasonable levels toward the end of 2009 but on January 1, 2010, banks went ballistic again, issuing US$160 billion in new loans in just the first two weeks of the year.
So, once again, the heads of the big state-owned banks were called in and handed new lending quotas. Some were even banned from making any further loans until the end of the month.
Compare such drastic action with an interest rate hike of 25 basis points and you will begin to understand why nominal interest rates in China are not the key monetary policy tool or indicator.
Meanwhile, the government and its regulators publicly denied any policy change whatsoever and stuck to its line of a "moderately loose" monetary policy.
Having spent many years dealing with Chinese financial regulators, I was not surprised by their blatant denials. I have witnessed numerous occasions when regulators have dispensed "window guidance" or "internal policies" that they deny even while the financial institutions publicly acknowledge these edicts. Eight months later, the regulator will announce the end to the policy whose very existence it has vehemently denied up until that point.
One example is the ban on initial public offerings that the China Securities Regulatory Commission imposed on a number of occasions when the stock market was in a serious slump. Each time the CSRC has repeatedly and publicly said that no such ban exists, only to lift the ban and explicitly admit its existence with great public fanfare after less than a year.
In the banking sector, "secret" lending quotas were imposed late in 2007, the last time the government was very concerned about economic overheating. Those quotas were strenuously denied by the central bank and banking regulator until the second half of 2008, when senior officials explicitly said the quotas were being lifted to help boost the economy.
Smoke and mirrors
The best explanation I have heard as to why Chinese officials are so reluctant to admit how much they meddle in the financial sector has to do with China’s relations with trade partners such as the US and Europe.
One of China’s top foreign policy priorities is to get other countries to formally recognize it as a "market economy" – not for the bragging rights but because that would make it much harder for those countries to prove anti-dumping cases against Chinese companies and exports.
That is why financial regulators must maintain a charade that they operate in the same way as their Western counterparts even as they micro-manage monetary policy at the institutional level.
