China announced on Wednesday that it will loosen its monetary policy to spur lending and give the Chinese economy a boost, The New York Times reported. The decision marks a reversal of policy that has seen the country become more stringent with its finances, particularly in the last year.
On Monday, December 5, the People's Bank of China will lower the reserve requirement for commercial banks by half a percentage point, the first such reduction since 2008. The ratio of deposits that banks must retain in the central bank has risen steadily over the past three years, with five increases in 2011 alone.
Following the change Monday, large banks will need to keep 21 percent of all deposits in the People's Bank. Smaller banks have a slightly lower ratio, 19 percent.
The half point shift will free up to 400 billion yuan, or approximately $63 billion, for loans, according to Mark Williams, chief Asia economist for Capital Economics in London. "We see this as a decisive shift in policy stance from China," he wrote in a report. "Further reserve requirement cuts will follow over the next few months. Bank lending will pick up."
The Chinese economy, which has been steadily growing for years, took a hit earlier this month when it was revealed that the country's manufacturing industry dropped to a 32-month low in November. Earlier this year, China's real estate industry faced similar problems, where low availability of loans for buyers resulted in some property values falling as much as 28 percent.
While much of the focus has been placed on improving China's stagnating real estate sector, manufacturing will also see an impact from the adjusted monetary policy. China's prior moves to increase the bank reserve ratio were in response to rising inflation, which caused product costs to increase. However, the European debt crisis has also caused exports to slow. The European Union is collectively the largest importer of Chinese goods, and its credit crisis also affected China's manufacturing slowdown.
Part of China's business strategy has been to keep the price of products, particularly exports, artificially low by devaluing its currency in order to keep labor costs down. By relaxing the country's fiscal policy and injecting more money into the Chinese economy, the central bank's decision could have a domino effect on Chinese manufacturing costs. First, easier access to loans for business could increase labor wages, causing an appreciation of the yuan, which would spur more internal buying by the Chinese. This activity will likely increase the country's inflation, with an end result of higher costs of goods to China's main customers: us.
Two hours after China's announcement, the Federal Reserve, along with five other central banks, released a plan to lower the interest rate on the U.S. dollar for struggling European countries seeking loans, in a move to stabilize the global economy. U.S. and Chinese parties claim the timing of both announcements was coincidental.
Wednesday's announcement was a collaboration between the Federal Reserve, the European Central banks and central banks in Canada, Britain, Switzerland and Japan. The plan will allow the Federal Reserve to loan U.S. dollars out to other central banks at dramatically lower interest rates. Those central banks can then makes loans to local banks. While the method is different, the purpose of the Fed's move is the same as China's: to inject more money into the economy now at a higher cost down the road.
Whether China's or Europe's plans will work is being debated, but investors across the globe showed their support for the plans. Markets in the U.S., Europe and Asia all rocketed higher, in some countries as jumping up as much as 4 percent, following Wednesday's announcements. It will still be a while before the actual affects of the new lending policies is felt; despite the initial euphoria in global markets, actual currency will not begin to flow out from banks for a few weeks, and the increased liquidity will not fully be felt until 2012.
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Kyle A. Richardson is the editorial director of Promo Marketing. He joined the company in 2006 brings more than a decade of publishing, marketing and media experience to the magazine. If you see him, buy him a drink.