China tells banks to step up lending to lift flagging growth

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China has told its banks to lend more in the final months of 2014 and relaxed enforcement of loan-to-deposit ratios to expand credit, sources told Reuters, as Beijing prepares to release data that could confirm the relentless slowing of its economy.

Figures on inflation, imports and fiscal spending in November have already undershot expectations since the People's Bank of China (PBOC) sprang a surprise interest rate cut on Nov. 21, raising fears that the bid to boost lending could foreshadow more weak figures on industrial activity for the month, due on Friday, and on lending, due in the next few days.

"I wouldn't be surprised by that at all," said Andrew Polk, resident economist for the Conference Board in Beijing. "It seems pretty clear activity is continuing to weaken throughout this fourth quarter."

Two sources with knowledge of the matter said China's central bank increased the annual new loan target to 10 trillion yuan($1.62 trillion) for 2014, up from what Chinese media have said was a previous target of 9.5 trillion yuan.

Will PBOC do 'whatever it takes' to boost economy?
Will PBOC do 'whatever it takes' to boost economy?   

Banks have disbursed 8.23 trillion yuan of loans between January and October, so they will have to quicken the pace in the last two months if they are to meet the new target.

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If upcoming data also proves worse than expected, some analysts say the PBOC could cut banks' reserve requirement ratio (RRR) as soon as this weekend, allowing them to further increase lending.

The PBOC did not answer calls requesting comment.

Bank lending is a crucial part of China's monetary policy as the government instructs commercial banks, most of which are directly or indirectly controlled by the state, how much to lend and when to lend each year.

The amount of new loans issued by Chinese banks fell by more than a third in October.

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"If credit supply is increased, it will certainly help economic growth in the first quarter," said Chang Chun Hua, an economist at Nomura in Hong Kong. "If this is true, it shows that the government is quite concerned about growth."

State news agency Xinhua cited a government statement on Thursday that referred to "relatively big downward pressure" on the economy, which is expected to grow at its slowest pace in nearly a quarter of a century this year.

Still hoping

Zhou Hao, an economist at ANZ in Shanghai who focuses on monetary policy, said the lending move showed that government was still hoping it could hit its 7.5 percent growth target for 2014.

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So far, however, the central bank's stimulus efforts haven't shown up in economic performance, but instead appear to have put a speculative rocket under the country's previously underperforming stock markets.

Any cut in the RRR also carries the risk of giving more fuel to asset bubbles.

Banks' reluctance to lend has been attributed by some to a shortage of liquidity resulting from sliding deposits.

That could explain why PBOC has, according to the two sources, been quietly allowing banks to lend out more than 75 percent of their deposits, effectively relaxing a rule that is aimed at containing risks to the financial system when borrowers default on loans.

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But increasing the supply of loans, including any cut in the RRR, will only boost economic output if there is demand for lending by borrowers who can put it to productive use.

Polk at the Conference Board says there is instead overcapacity in the manufacturing sector and a reluctance to borrow, which explains why interest rates remain low.

"A little reduction in average rates suggests it's the loan demand side driving some of the pullback in credit creation, which also calls into question the ability of the central bank to push through such an increase in lending at the end of the year," he said.