The start of a year is a new accounting period. Credit flood gates open and firms take out as many loans as they can, in advance of actual needs. By the second half of a year, banks have historically over- extended guidelines on loans from the central bank, forcing the latter to shut the gates.

Thus, firms often sit on the cash from loans for awhile before they spend/invest it. During a tightening phase, they cannot delay longer, hence the flattening of business deposits as they spent. The cash goes into the bank accounts of individuals--the firms' workers and service providers, resulting in accelerating household deposits. Indeed, with the recent tightening measures, household deposits are now turning upwards (Chart 5).

In short, when tightening occurs, China's economy can actually accelerate for awhile as firms spend/invest their cash, and households, with rising cash on hand from gains in income, sustain their consumption growth pattern.

Table 1 shows corporate bank deposits at ~65% of GDP at end 2009, up by the equivalent of 13% of GDP, thanks to the bank loan surge of 2009. Thus, ample liquidity remains in the system. What's going on at present in China is a credit slowdown, not monetary tightening.

Implications
China's economy will continue to grow at a robust pace, propelled increasingly by private consumption. The government, in particular, has singled out consumption and investments in the rural economy (population of over 650 million) as one of the growth engines. Sectors and companies exposed to these segments of the economy will be key beneficiaries.

We can expect a few property developers who overextended on land purchase commitments to suffer cash flow issues. The top-down policy now is to curb land hoarding, forcing the supply of homes to rise. Chart 6 shows pre-sale volumes doubling, especially in 2H09, over the pace of the prior three years. Home construction activities will thus be very buoyant in the next 18-24 months as pre-sold homes are completed. But with a rising supply, home prices are set to decline moderately. Property developers will suffer, but real estate agency businesses will prosper.

Eoin Treacy's view The Chinese stimulus package was successful in averting the worst effects of the global recession and now that growth is returning to trend, the delicate operation of withdrawing excess liquidity is underway. Reserve requirements have already been raised and investors are beginning to position themselves for interest rate hikes. Speculation has also increased that there will be a move in the exchange rate, particularly if inflation becomes more of an issue.

From a stock market perspective, the CSI300 Index of Shanghai and Shenzhen A-Shares is heavily weighted by the Financials (36.9%), Industrials (16.5%) and Materials (14%) sectors. The Financials sector, which comprises banks, insurance and property companies, is sensitive to liquidity tightening and the other large weightings in the Index are focused on exports which remain vulnerable due to diminished demand in key markets.

Today's downside key day reversal is a blow to the consistency of the short-term advance from last month's lows. However, a sustained move below 3100 would be required to indicate a more pronounced test of underlying trading.

The authorities have made clear their intent to move the focus of policy from fixed asset investment to a domestic consumption led model and that they want to continue to move up the value chain in terms of manufacturing. This process will take time and is unlikely to unfold without some hiccups along the way. The relatively small weightings of the Consumer Discretionary (9.4%), Consumer Staples (4.5%), Healthcare (4.1%) and Information Technology sectors (2.6%) suggest that it will take a while before they have a greater influence on the direction of the wider market.

Nevertheless, the Healthcare sector continues to test its highs, the information technology sector is also consolidating below its high and the consumer staples and discretionary sectors remain in relatively consistent uptrends. This action suggests investors are falling in behind government pronouncements that these are the areas emerging as the focus of the medium-term development agenda.