China Tackles Liquidity Again – WSJ

Posted on February 19, 2011 by

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CHINA’S central bank, continuing its battle against inflation, said yesterday it would raise the bank reserve requirement ratio by 0.5 percentage points, the second such hike this year. Economists expect more tightening to come.

The hike came as Group of 20 finance ministers and central bankers met in Paris to discuss, among other subjects, Chinese economic policy. As has happened before other such meetings where Beijing tries to avoid international criticism, China let its currency move higher, reaching a record level under the current system of 6.5732 against the US dollar.

Overall, the yuan has appreciated about 3.8 per cent since China let its currency float somewhat in mid June. The US Treasury and other G-20 countries argue China should let its currency appreciate faster to tamp down inflation by making imported goods cheaper in yuan terms. The Chinese government says, though, it isn’t using exchange rate policy in that way, and the slow pace of appreciation suggests the government is being candid.

Instead, China generally relies on hiking the level of bank reserves, which quickly drains money from the financial system.

With the latest hike, Chinese reserve rates are between 19.5 per cent and 20 per cent — among the highest in the world. But economists say such measures have big downsides. Rationing credit in practice means lending is restricted to big state-owned enterprises, which are seen as risk-free borrowers, rather than small and medium-sized private firms.

For China to advance economically, many economists argue, it needs to encourage innovative small firms rather than lumbering state-owned ones.

The rate hike increase, which will take effect next Thursday, was widely expected amid surging liquidity, particularly during the Chinese New Year. Credit Suisse forecasts another increase of 1 percentage point in reserve requirements this year and also a 1.6 percentage-point increase in the benchmark one-year lending rate to 7.66 per cent

The PBOC raised benchmark lending and deposit interest rates earlier this month. It raised the reserve requirement ratio six times and benchmark interest rates twice in 2010. The last reserve ratio hike took effect January 20.

“Beijing was relatively slow to start normalising monetary policy over 2010 and this contributed to the recent acceleration in headline inflation. But policy makers have definitely picked up the pace in the last few months, and today’s move is the latest sign of this increased sense of urgency,” said Brian Jackson, an economist from the Royal Bank of Canada.

Latest data showed the consumer-price index rose 4.9 per cent last month, up from 4.6 per cent in December — with food price inflation remaining at around 10 per cent — and economists say they expect the CPI to rise further in February due to an increase in demand during the Lunar New Year holiday.

Mr Jackson said he expects more policy tightening in the coming months, including additional increases in interest rates and a faster pace of currency appreciation.

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