GOODBYE, 2010, and hello, 2011! Time marches on, and so, too, China's efforts to keep its monetary and banking policies calibrated to economic changes.

The nation's leaders have altered their monetary language from "appropriately loose" to "prudent." In financial lingo, the shift in semantics is an important one, economists say. It signals that the freewheeling spending that helped China survive the global financial crisis in such good shape may be moderated in 2011 to cope with the reality of runaway inflation.

At the annual central economic work conference, when China's top leaders adopted economic policies for the first year of the 12th Five-Year Plan period between 2011 and 2015, the main focus seemed to shift from growth to inflation and the need to counter the expanding cheap money supply coming out of the US.

More interest-rate increases are expected in China in 2011, economists tend to agree.

"The key risk is inflation for the time being," said Qu Hongbin, chief economist of HSBC in China. "The country should focus on curbing inflation in the coming months."

Some economists are forecasting as many as four rate rises next year as policy makers grapple with spiraling prices that are hurting consumers. China has been relying heavily on raising the amount of reserves banks are required to keep on hand to mop up excess liquidity, but that may not be enough.

"Quantitative tightening has limited effects on inflation," said Liu Ligang, an economist with Australia & New Zealand Banking Group. "Interest rates are still the most effective tool to counter inflation."

Better returns

For the man on the street, more deposit rate increases at the first sight translate into better returns on savings. However, considering that inflation is expected to rise by 4-5 percent next year, even four more interest rate rises, at 25 basis points each time, mean that households will still have to confront a negative savings rate. That may explain why savings keep draining out of bank accounts, seeking better rates of returns.

On the lending front, the rate increase means borrowers, such as home mortgage takers, will pay more for their homes from 2011. For instance, for Tom, a home buyer who borrowed 1 million yuan (US$150,376) on a 20-year loan on benchmark rate, he has to pay 267.24 yuan more each month from next month after the two rate increases.

Lenders may face brighter prospects, at least in the short term.

China has raised its interest rates twice since October to curb inflation. The benchmark lending rate was raised by 25 basis points yesterday to 5.81 percent on one-year money. One-year deposit rate was also raised by a quarter-point to 2.75 percent, still leaving savers with negative returns when November's 5.1 percent inflation is factored in.

For on-call deposits, the rate for savers remained at 0.36 percent.

"The lion's share of bank deposits are for less than a year, while most loans are long-term," said Qiu Guanhua, a Guotai Jun'an Securities Co researcher. "So, asymmetric rate rises increase the interest rate spread."

In other words, banks are taking in money from savers at low rates, then turning around and lending it out at much higher rates.

Citibank said in a report that more than 90 percent of deposits are for less than one year. Most Chinese households prefer shorter-term deposits so they can retain more ready access to their savings.

In the long run, rate increases may hurt banks, especially if regulators impose more limitations on lending, as they have done for mortgages.

Excess liquidity is blamed for driving up inflation, as investors rushed to invest in stocks, housing and even garlic, mung beans, ginger and other foodstuffs.

The Consumer Price Index for November showed a whopping 11.7 percent surge in food prices. Chinese consumers are feeling the biggest cost-of-living pinch in a decade, a central bank survey this month showed.

Wang Qian, a JPMorgan economist, said she expects China to set a loan target of around 6 trillion to 7 trillion yuan (US$1.13 trillion) in 2011, down from 7.5 trillion yuan for 2010.

Banks in China are set to surpass this year's target. In the first 11 months of this year, 7.4 trillion yuan in loans were reported. Still, that's less than the record 9.6 trillion yuan of new loans in 2008.

Authorities are wary about the risk of increased bad loans next year and have already ordered banks to lift their provisions.

The ratio of bad loans may rise to 2 percent, after factoring in local government debt and the tightening in the real estate sector, the nation's top banking regulator has said. Still, that's not a particularly big problem. "As a developing country, a 2 percent non-performing-loan ratio is considered realistic and reasonable," said Liu Mingkang, chairman of the China Banking Regulatory Commission.

The bad-loan ratio of Chinese banks stood at 1.2 percent as of the end of September.

Reserve requirements

For banks, the "prudent" monetary policy probably means higher reserve requirements to curb their lending. The People's Bank of China raised the reserve requirement six times to a high of 18.5 percent for major banks this year.

Economists said they are waiting to see how monetary policy is adjusted further if inflation exceeds the government forecast.

For 2011, China has set targets of 4 percent for inflation, 8 percent for economic growth and a 16 percent rise in money supply, Bloomberg News reported, citing two sources who declined to be identified. The targets have yet to be officially announced.

China is expected to unveil targets for money supply and loans in March.

For 2010, money supply growth has been running at a pace of more than 19 percent, exceeding the government's 17 percent target.

On the currency front, opinion is divided. HSBC's Qu said he expects the currency to be stabilized at "a reasonable equilibrium level."

He added: "Exchange rate appreciation would not be much help to check inflation, not least because China's huge demand has already made it a price-setter in global commodities market."

Liao Qun, chief economist of CITIC Bank International, said he expects the pace of yuan appreciation to be faster than the 3-5 percent previously forecast. He's forecasting a gain in value against the US dollar next year of between 4 percent and 6 percent.

"Further quantitative easing in the US triggered more overseas requests for acceleration in the value of the yuan," Liao said.

A more valuable yuan can make imports cheaper and exports dearer, but its impact on inflation is less clear in a nation where the currency is under tight government control.

The yuan resumed its appreciation pace since June 19, when the central bank pledged to pursue a more flexible foreign exchange policy and drop its two-year de facto peg to the US dollar. The local currency has gained more than 24 percent since July 2005, when China dropped its official peg to the US dollar. The yuan's daily trade band is now 0.5 percent.

For households, the best way to take advantage of any rise in the local currency is to keep their assets denominated in yuan. The easiest way is to keep the local currency.

For more sophisticated individual investors, economists offered this advice: "We expect domestic pressures to prompt a faster appreciation of the Chinese yuan," said Deutsche Bank in a report. "Yuan forwards are the cheapest way to access the local currency. We suggest buying the yuan versus a basket of US dollars, euro and Japanese yen."