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China Battles Inflation, Raises Bank Reserves Again

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(By Kevin Yao and Koh Gui Qing) BEIJING: China's central bank raised lenders' required reserves on Friday for the fourth time in just over two months, stepping up the fight against inflation that it has vowed will be a top priority for the year.

By forcing banks to lock up more cash with the central bank, Beijing hopes to drain excess money from the economy and tame rising prices, which it worries may stir social unrest.

The move, well anticipated after China's top leaders planted the task of taming inflation at the top of their agenda, underscores the central bank shift to "prudent" monetary policy in December, from its previous "moderately loose" stance.

With inflation expected to stay elevated in coming months, barring a temporary dip in December from 28-month highs, analysts believe more tightening is on the cards.

"The rise is within market expectations, showing that the central bank is really concerned about inflation," said Dong Xian'an, chief economist at Industrial Securities in Beijing.

"We expect the central bank to raise interest rates once or twice more in the first quarter, and we expect two more RRR rises in the same period."

The 50-basis-point increase, effective January 20, will raise the reserve requirement ratio (RRR) for China's biggest banks to a record high of 19.5 percent.

Announced by the People's Bank of China in a terse statement published on its website www.pbc.gov.cn after the Chinese stock market (.SSEC) .SS had closed, it triggered knee-jerk selling in riskier assets such as the euro and oil.

PLENTY OF CASH

The move will drain about 350 billion yuan ($53 billion) from the Chinese economy, but given the speed at which new money is entering the system through trade and investment it is no wonder many believe more reserve requirement increases are due.

China's foreign exchange reserves surged a record $199 billion in the fourth quarter to $2.85 trillion, compelling the central bank to counter the inflationary effects of such money inflows via sterilization, or selling yuan-denominated bills to domestic institutions to mop up excess liquidity.

The central bank has to buy most of the incoming foreign currency to keep the yuan stable, pumping huge amounts of local currency into the banking system as a result.

Yet, it faces difficulties in selling bills to banks in recent weeks due to depressed auction yields.

Zealous lending by banks are not helping as well.

Chinese banks doled out close to 500 billion yuan in new loans in the first week of January, according to sources [ID:nTOE70B05Z], following a lending spree of 7.95 trillion 2010 that over-shot the central bank's loan target.

STUBBORN INFLATION?

China's inflation hit a 28-month high of 5.1 percent in November as food and property prices soared.

Given oil prices have jumped above $90 a barrel and global commodity prices have headed higher in recent months on the back of harsh weather, some analysts warned price pressures may not abate soon.

China is not the only country battling inflation amid rising food and energy prices. Central banks in South Korea and Thailand both raised rates this week.

In order to rein in inflation, analysts believe China has to use an array of policy tools including raising interest rates and allowing the yuan to rise faster.

"I do expect further RRR hikes in China," said Tommy Xie, an economist at OCBC Bank in Singapore. "Inflationary pressure in China is still very high and credit expansion remains strong."

(Editing by Jacqueline Wong and Alex Richardson)

Copyright 2010 Thomson Reuters. Click for Restrictions.

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