People’s Bank of China’s decision to raise by 50 basic points the banking system’s reserve is an attempt to curb lending. The move, 5th of this kind, marks the beginning of a long war. The enemy is subtle and dangerous: inflation, which requires an accurate strategy. CPI is on the rise; it reached 4.4% YOY, but food prices climbed 10.1%. Low-income earners are the most hit, mainly in the countryside. Consequently, stability and consensus might be at risk.
The Government chooses the most immediate way to tackle inflation by reducing money supply. But the loan-to-deposit ratio is low in China and the mandatory reserve increase at the PBOC cannot tame significantly the inflation. The Nation had and still has different options. The traditional rise of interest rate is forthcoming. Another path to follow towards the same goal would have been to revaluate the RMB more significantly. As a consequence, prices of imported goods – e.g. raw materials and energy – will have been reduced and inflation tamed.
This decision, though, has political implications and could be interpreted as a surrender to external pressures. New measures will be introduced for the needy and to increase the availability of basic supplies. Prices of food products, fuel, coal, energy will be blocked and controlled. Financial markets do not like such price control. The first signal came from Shanghai Stock Exchange, where the index fell almost 10% in the last 2 weeks. Forced prices freezing is effective only for short periods. In the past, after few months of price controls, companies, even SOEs, refused to supply coal and gasoline below its cost. Black market and smuggling came up as a result. In conclusion, China has many weapons to fight inflation, even though to raise the banks’ deposit is the simplest one. It does not guarantee the final victory, but at least offer some time to plan a more effective strategy.