China's central bank said on Thursday it is to enhance its macro management capacity to ensure an appropriate loan growth.

In its first-quarter monetary policy report released on Thursday, the People's Bank of China (PBC) said rapid growth in trade surplus and foreign exchange reserves is posing a severe challenge to the effectiveness of its monetary policy.

China's forex reserves continued on an upward climb in the first quarter of the year, rising by 8 percent from the end of last year to US$659.1 billion, partly on the back of a greater trade surplus.

The increases in forex reserves theoretically translate into a far larger amount of local monetary supplies, which the PBC is trying to stem to prevent the economy from overheating.

The bank said it will further increase the effectiveness of open market operations, a major monetary policy tool, in buffering the impact of factors such as forex reserve increases.

Inflationary pressures "still deserve attention," it said, noting that while consumer prices are largely under control, producer price increases were more rapid in the first quarter than for the same period last year.

Inflationary pressures are a major factor when the PBC considers the possibility of a further interest rate increase this year, but many analysts have said the pressures are not yet strong enough to justify an immediate rate rise.

The bank announced its first interest rate increase in nine years last October, and another is expected sometime later this year.

In other news, the central bank formally endorsed the role of private financing in a report released on Wednesday.

Private financing could optimize the allocation of financial resources and reduce lending risks in the banking system, although it challenges the regulators' supervisory capacity and may be a potential threat to financial and social stability, the report said.

The PBC's China Regional Finance Report is the first official recognition of growing lending activities between Chinese individuals and private enterprises. Analysts believe private financing has been a major engine in driving the growth of China's private sector over the past few years.

"In order to promote the healthy development of private financing, there needs to be better policy guidance and financial innovation to promote the circulation of funds," the report said.

Further legislation is needed to clarify the difference between private financing and illegal fund raising among the public, and efforts will be made to encourage participants to officially register private financing operations.

Financial innovation needs to be enhanced while restrictions on private investment in some sectors are removed to provide more room for private funds, the bank said.

Wealthier private entrepreneurs and farmers put more of their funds into the private lending market last year as it offered higher returns than the stock market which remained weak.

The trend was reinforced by readjustments to lending policies at commercial banks, many of which are closing down unprofitable branches in far-flung areas, and tightening lending to small businesses largely because of risk and cost concerns.

Last year, Chinese banks were urged to restrict lending to overheated sectors such as steel and cement as part of efforts to stabilize the economy's phenomenal growth. But economists say some banks have been excessively strict in lending and many small firms are suffering liquidity difficulties because of this.

According to a PBC survey, private funding accounted for 15-25 percent of new lending last year in east China's Zhejiang Province, south China's Fujian Province and north China's Hebei Province.

The strong funding demand pushed up interest rates to as high as 14.4 percent in Wenzhou, Zhejiang Province, more than twice the corresponding bank rate.

As for the financial industry, the central bank said overall loan growth slackened last year as macro management continued. Loan growth in more than half of the provinces, autonomous regions and municipalities fell within the 10-20 percent range.

Backed by rapid business expansion, most financial institutions in central and western China made a profit last year, with those in northwest China's Gansu Province reporting their first combined profit in 20 years.

(China Daily May 27, 2005)