Collapse of the Global Economy

China Raises RRR Again as Inflation Fight Intensifies

November 19, 2010

Reuters – China ordered lenders on Friday to lock up more of their money with 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.

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 a temporary increase, the move takes required reserve ratios (RRR) to 18.5 percent for big banks, a record high.

The increase 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).

The move 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. The Australian dollar, which is sensitive to the strength of Chinese demand, fell briefly against the U.S. dollar.

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.

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.

LOCKING UP CASH

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 RRR increase, which takes effect on November 29, should lock up about 350 billion yuan 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 United States 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.

"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 in London.

"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.

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, Beijing called on banks to lend more aggressively.

Banks responded by unleashing 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.