A surprise rebound in money supply growth gave China's central bank a stark reminder on Monday of the policy problems posed by a soaring trade surplus.
Annual growth in the broad M2 measure of money supply accelerated to 17.1 percent in October from 16.8 percent in September, despite a barrage of measures in recent months to curb money, credit and investment growth.
New lending did in fact slow to a trickle in October, partly due to the policy restrictions and partly on seasonal grounds. But the cash spun off by October's record $23.8 billion trade surplus helped pump up M2 growth beyond market forecasts for a 16.5 percent rise.
"As long as that is growing very quickly, it is actually very difficult to control lending growth," Paul Cavey, an economist with Macquarie Securities in Hong Kong, said of the M2 data.
He said the money and trade figures showed that Bejing was on the horns of a policy dilemma: by reducing demand for imports, curbs on investment were inflating the trade surplus, which was inundating the banking system with cash. "I think the liquidity situation is going to get worse in the next few months because the trade surplus is going to grow bigger," Cavey said.
Since April, the central bank has raised interest rates twice and on three occasions ordered banks to hold more deposits in reserve instead of lending them out. Resorting to increases in required reserves shows the difficulty of managing money supply when the yuan is significantly undervalued, economists at Goldman Sachs said.
The yuan rose on Monday as high as 7.8623 per dollar, the loftiest level since it was revalued by 2.1 percent to 8.11 in July 2005 and cut loose from a decade-old dollar peg. It has now gained a further 3.15 percent, but many economists say that, to cap the gusher of cash at source, China should put aside its caution and let the currency rise more swiftly to a level that will crimp exports.
"We expect the central bank to maintain a tightening bias in monetary policy operations in the near term," Goldman said. A saving grace for the central bank is that, despite the flood of easy money, price pressures remain in check. Figures on Monday showed annual consumer inflation slowed to 1.4 percent in October from 1.5 percent in September.
The figure was lower than the 1.6 percent forecast of economists polled by Reuters and followed a surprisingly steep fall on Friday in annual factory-gate inflation to 2.9 percent in October from 3.5 percent in September.
"This really takes away any worries at all about inflation in China," said Tim Condon, head of Asian financial market research at Dutch bank ING in Singapore. A slower rise in the price of food, which makes up a third of the consumer basket, pushed the overall rate of inflation lower.
The National Bureau of Statistics said food cost 2.2 percent more in October than a year earlier, compared with a 2.4 percent rise in September. Vegetable prices dropped at an annual pace of 5.7 percent last month, possibly due to unusually mild weather.
Goldman responded to the weaker-than-expected readings by lowering its inflation forecasts for 2006 and 2007 to 1.4 percent and 2.2 percent from 1.8 percent and 2.8 percent, respectively. Clothes, cars, tuition and telecommunications recorded outright price falls in October from a year earlier, but Condon said fears China could relapse into deflation were far-fetched.
China suffered falling prices in 2002, 1999 and 1998, but Condon said those episodes were associated with recession in the United States and the aftermath of the Asian financial crisis. "The global backdrop is much more supportive today than in either of those episodes. I think we'll see low inflation, rather than deflation," he said.
Ben Simpfendorfer with Royal Bank of Scotland in Hong Kong said benign inflation meant policy makers could focus on tackling the consequences of China's bulging external surpluses. "There are few implications for policy," he said of the inflation report. "This provides them little bit of leeway, so they have room to focus on the trade surplus."