Some readers may find this topic quite familiar as we have repeatedly discussed China's excessive liquidity problem. The authorities clearly see the magnitude of the issue but its troubles are far from over, judging from recent statistics released by the People's Bank of China (PBoC).

The PBoC figures show incremental yuan lending in November reached 564 billion yuan, higher than the market expectation of 500 billion yuan. The November loan figure was actually down from 587.7 billion yuan in October, but still 269.2 billion yuan higher than in the same period last year. Incremental loans to households saw a slight rebound from 165.6 billion yuan in October to 189.6 billion yuan in November, albeit lower than the high levels seen in the first half of 2010.

Amid tightening mortgage policies, new household loans are likely to see a further decline in the first half of 2011. For non-financial sectors, discounted bills dropped by 15.6 billion yuan in November after decreasing 0.1 billion yuan in October, reflecting banking's efforts in meeting the authority's lending quota.

Meanwhile, new short-term loans rose from 147.1 billion yuan in October to 167 billion yuan during the past month, while medium to long-term loans dropped to 193 billion yuan in November from 240.7 billion yuan in October. We notice that new household mortgage loans and incremental medium and long-term loans to non-financial corporations started to show a significant decline from October, obviously lagging the launch of tightening policies in the second quarter of 2010. Such a time lag was probably due to the transfer of some off-balance assets into on-balance assets.

Yuan loans in November grew 19.8 percent YoY (all on a year-on-year basis below unless otherwise specified), compared to the increase of 19.5 percent in October. M2 growth saw a further pick-up of 19.5 percent in November after rising 19.3 percent in October and 19 percent in September, while M1 jumped 22.1 percent in November, the same as in October. The M0 slightly decelerated from 16.6 percent in October to 16.3 percent in November, after taking out the holiday effect in October. The pick-up in M1 and M2 was actually beyond our expectations, mainly caused by a significant surge of capital flows into China as well as more-than-expected new banking loans. Looking forward, we believe that M1 and M2 figures will see gradual mitigation in the long term due to a decrease in new lending and a rise in the comparison base. However, it may stay at high levels in the short term, boosted by surging capital inflows.

On the other hand, total incremental deposits amounted to 592.4 billion yuan in November, up from 176.9 billion yuan in October, significantly down from 1,450 billion yuan in September, which was mainly caused by a rebound in savings deposits. In November, savings deposits returned to a month-on-month increase at 133.2 billion yuan, compared with a decline of 700.3 billion yuan in October. The new enterprise deposits also picked up from 416.8 billion yuan in October to 573.7 billion yuan in the past month, supported by the surge in capital inflows and consecutive high incremental loan figures.

Meanwhile, fiscal deposits registered a month-on-month decrease of 211.9 billion yuan after increasing by 299.2 billion yuan in October. We expect that fiscal deposits will see a more significant decline while enterprise deposits will show a further increase in December with substantial budget funds to be transferred from fiscal deposit accounts in the central bank to private deposit accounts in commercial banks at the year end. Such a fluctuation will also have an influence on the base money.

After all, we think that consecutive months of higher-than-expected new loans actually reflect surging capital inflow and a bit of a rebound in the banking system's lending impulse in the past three months. Total new loans in the first 11 months amounted to 7.44 trillion yuan, getting very close to the full-year target of 7.5 trillion yuan. Meanwhile, inflationary pressure is unlikely to be alleviated before the third quarter of 2011.

And the situation presents huge challenges to the mainland's authorities. The PBoC already announced another hike in the required reserve ratio (RRR) earlier this month and we expect the central bank to continue to use the RRR hike and other quantitative tools to control increased liquidity and lending expansion in future. In the aftermath of a higher-than-expected consumer price index (CPI) in November and the likelihood of a high figure this month, we cannot rule out the possibility of an interest rate hike before the Chinese New Year holiday in early February.

Peter Pak is Executive Director of BOCI Research Limited. The opinions expressed here are entirely his own and do not represent BOCI or any other affiliated companies within the group. Nothing in this article constitutes an investment recommendation to you.

(HK Edition 12/25/2010 page2)