The People's Bank of China (PBoC) has been using interest rate hikes as well as required reserve ratio (RRR) adjustments as two major weapons in its arsenal in a bid to curb excessive liquidity since the second half of last year.

Latest statistics on new lending have showed a continuous downward trend, indicating that the policies are starting to work.

In May, incremental yuan loans declined to 552 billion from 739.6 billion in the previous month, slightly lower than the market consensus of 600 billion. The decrease in new lending reflects the impact of the tightening policies, particularly on lending to so-called local government financing vehicles (LGFV) controlled by local State-owned enterprises (SOEs).

Meanwhile, incremental loans to households also decreased to 218 billion yuan in May from 247 billion yuan in April. In the wake of tightened mortgage policies, new loans to households are likely to see a further decline going forward.

For non-financial sectors, new discounting lending climbed from 40 billion yuan in April to 57 billion yuan in May. Discounted bills have shown consecutive month-on-month declines in most periods since the second half of 2009, reflecting banks' efforts to meet the lending quota set by the authorities. As most of this discounting financing has matured, it turned to a positive increase two months ago.

On a year-on-year basis, new yuan loans grew 17.1 percent in May, lower than the 17.5 percent increase in April and 17.9 percent in March. M1 growth also eased significantly to 12.7 percent from 15 percent in March and 12.9 percent in April, while M2 growth in May also slowed down to 15.1 percent from 15.3 percent in April. Although incremental loans have stayed relatively high in the past few months, M1 growth has slowed steadily since the beginning of the year, reflecting enterprises' strapped cash flows.

M1 is expected to post relatively low growth for most of the remaining months of this year, amid ongoing tightening policies. As there have been consecutive negative real-term deposit rates since last year, both deposit and M2 growth might maintain much lower growth rates compared with last year.

The PBoC is also still facing huge challenges from intensified inflation pressures and the continuing huge liquidity inflow. The year-on-year growth of the consumer price index (CPI) may reach a new high for the month of June. Meanwhile, economic growth is likely to a see gradual mitigation going forward, but I do not foresee the possibility of a hard landing because of the still-high investment and consumption demand.

I believe the authorities will maintain a relatively tight lending policy while the current administrative policies over the property sector are not likely to be relaxed before year-end. I still believe that the PBoC will raise the RRR two or three more times, and the one-year lending and deposit rates are expected to rise to 6.81 percent and 3.75 percent by end-2011, respectively.

As the PBoC will probably maintain relatively tightened policy operations, M2 and loan growth should fall to a level near the official target this year.

The author is executive director of BOCI Research Limited (www.bocigroup.com). 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.

(HK Edition 07/07/2011 page2)