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China raises bank reserves as inflation fight intensifies
November 19, 2010 / 10:49 AM / 7 years ago

China raises bank reserves as inflation fight intensifies

BEIJING (Reuters) - China ordered lenders on Friday to lock up more of their money at the central bank for the second time in two weeks, stepping up its battle to pull excess cash out of the economy before inflation has a chance to take off.

<p>Yuan banknotes are seen in this illustrative photograph taken in Beijing in this September 19, 2010 file photo. China's central bank said on November 19, 2010 it will raise banks' reserve requirements for the second time in two weeks, stepping up its battle to rein in prices before inflation has a chance to take off. REUTERS/Petar Kujundzic/Files</p>

The People’s Bank of China said that it would increase banks’ required reserves by 50 basis points, its fifth such announcement this year. Including an earlier temporary increase, the move takes required reserve ratios (RRR) to 18.5 percent for big banks, a record high.

The tightening step was intended “to strengthen liquidity management and appropriately control money and credit issuance,” the central bank said in a statement on its website (www.pbc.gov.cn).

It was not a surprise and, in fact, could be something of a relief for investors who had expected worse.

“It suggests China is intent to manage price pressures through withdrawing liquidity from the system,” said Dongming Xie, China economist at OCBC Bank in Singapore. “However, it also suggests that China is being cautious about aggressive monetary tightening.”

The central bank made the announcement after domestic markets had closed for the weekend.

But European stocks extended their losses after the news. Big miners Rio Tinto (RIO.L) and BHP Billiton (BLT.L) were both down more than 2 percent on worries that tighter monetary policy would reduce China’s appetite for commodities.

Oil futures weakened and the Australian dollar, which is sensitive to the strength of Chinese demand, fell against the U.S. dollar.

China’s ruling Communist Party is acutely sensitive to inflation as a political issue. Rising prices added to discontent in the buildup to widespread anti-government protests in 1989.

Inflation now is mild by comparison and though plenty of consumers have been grumbling about higher food prices, the strains have not been enough to unleash unrest.

MORE TIGHTENING AHEAD

Chinese stock markets have tumbled nearly 10 percent over the past six trading days on concerns that the government would ratchet up its monetary policy tightening after inflation sped to a 25-month high in October above 4 percent.

Such concerns were crystallized when China’s cabinet vowed on Wednesday to take “forceful” measures, including price controls if necessary, to rein in inflation.

“This RRR hike will not reduce the chance of raising interest rates, and I expect the central bank will raise benchmark rates one more time within the year,” said Lu Zhengwei, chief economist at Industrial Bank in Shanghai.

China raised interest rates on Oct 19 -- the first time in nearly three years -- and most analysts still expect 2-4 more increases by the end of next year.

Increasing reserve requirements is a more direct approach to absorbing the excess liquidity that has been spurring Chinese inflation.

The 50 basis point increase, which takes effect on November 29, should lock up about 350 billion yuan ($52.7 billion) that banks could otherwise lend.

Along with playing a key role in the fight against inflation, policy tightening also signals the government’s confidence that the world’s second-largest economy is on solid ground, even as the U.S. and European recoveries remain fragile.

In addition to increasing required reserves and interest rates, China has also issued strict orders to banks to curtail their lending.

WEIGHING ON COMMODITIES

“China tightening reserve requirements is just part of the arsenal that they will use and we would expect to see more of these measures coming through,” said Michael Lewis, global head of commodities research at Deutsche Bank.

“Our sense is that energy and industrial metals are most exposed to this sort of Chinese action because obviously it is going to raise people’s concerns about the growth outlook,” he added.

The move by China’s central bank could also cause a funding squeeze for some firms as banks without excess reserves are forced to call in loans, forcing companies to seek alternate funding sources and operate with less working capital.

Chinese policy makers have blamed monetary easing in the United States for propelling cash toward emerging markets, fuelling commodity price rises and inflation risks.

But most of the excess cash that lies at the root of inflation in China has domestic origins. To power the economy through the global financial crisis, state-owned banks unleashed an unprecedented credit surge and the government has been slow to mop up the money still cascading over the economy.

Food prices have driven Chinese inflation. Accounting for about a third of the consumer price index, food costs rose 10.1 percent in the year to October, while non-food inflation crept up just 1.6 percent.

Overall consumer price inflation reached 4.4 percent in October from a year earlier and many analysts expect that the November figure could breach 5 percent.

The government’s target was to keep inflation at a full-year average of 3 percent, but that is increasingly looking in doubt.

($1=6.636 Yuan)

Additional reporting by Kevin Yao; Editing by Don Durfee and Neil Fullick

Our Standards:The Thomson Reuters Trust Principles.
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