China Hikes Reserve Requirements

NEW YORK (TheStreet) - It's all about monetary tightening in emerging markets today.

The PBOC hiked reserve requirements another 50 basis points today, effective Jan. 20, and has hiked a total here of 350 basis points since starting in January 2010. This comes after the Christmas hike in policy rates that took the one-year lending rate to 5.81% for a total of 50 basis points tightening since starting in October 2010.

It appears that the PBOC may be front-loading its tightening measures, but markets should not think that such an aggressive tightening path will be seen all year. We downplay risks of a China hard landing, but acknowledge that markets will remain nervous until data confirms that this negative outcome has been avoided.

As we noted before, the last PBOC tightening cycle in 2006-2007 saw a combination of reserve requirement hikes, policy rate hikes, and CNY strength, and that's what we are likely to see in 2011 as well.

Why are we so confident that China can manage its economy to avoid a hard landing? In 2008, the Chinese economy was already slowing when the financial crisis hit Asia, and so PBOC quickly reversed course and cut the one-year lending rate by 216 basis points from September to December 2008.

The reserve requirement was also cut 200 basis points, and CNY appreciation was shelved from mid-2008 to mid-2010. Fiscal stimulus was also seen, and as a result, China GDP growth never slowed below 7.5% year over year.

We look for 8% growth in 2011, which should be enough to allay fears that China is slamming on the brakes. In terms of CNY strength, we think 12-month NDFs pricing in 2.4% gains are understating the likely appreciation, and we look for something closer to 5%. We also see another 75 basis points of policy hikes in 2011 along with perhaps another 100 to 150 basis points of reserve requirement hikes.

Looking ahead to the rest of Asia, the India WPI jumped to 8.4% year over year in December from 7.5% year over year in November, and points to another likely hike by the RBI when it meets Jan. 25 as price pressures remain an ongoing issue.

Indonesia central bank Governor Nasution also made hawkish comments and appears to be preparing the markets for a rate hike. However, he warned that the bank will take measures to limit capital inflows if the rupiah were to gain too much.

We think the odds are rising for the first hike at the Feb. 4 meeting. Coming after BOK and BOT hikes earlier this week, all these developments in the emerging markets underscore that wider interest rate differentials will continue to encourage inflows into emerging markets and that policy-makers will continue to try to manage the resulting currency gains.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

More from Emerging Markets

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

U.S. Stock Futures Steady; Asia Stocks Mostly Lower

U.S. Stock Futures Steady; Asia Stocks Mostly Lower

Jim Cramer: There Are Plenty of Shorts in Constellation Brands

Jim Cramer: There Are Plenty of Shorts in Constellation Brands

Renault Shares Hit 10-Year High on Nissan Merger Report

Renault Shares Hit 10-Year High on Nissan Merger Report