China's central bank on Monday raised the level of deposits that lenders must hold in reserve for the ninth time in 13 months, the latest step in its campaign to keep the world's fourth-largest economy from overheating.
Few economists were surprised by the move - though the central bank seldom announces policy moves on Mondays - because China's breakneck export-driven growth is inundating the economy with cash that is pumping up money growth and asset prices.
US Treasury Secretary Henry Paulson will urge China to curb its export growth by letting the yuan rise faster when he meets President Hu Jintao and central bank chief Zhou Xiaochuan in Beijing on Tuesday and Wednesday.
"It does look like the policy makers have been stepping up policy measures to try to deal with the external imbalances and the liquidity that that's created, which has in turn fuelled frothy asset markets," said Rob Subbaraman, chief economist for Asia ex-Japan at Lehman Brothers in Hong Kong.
The Shanghai stock market gained 2.2 percent on Monday to close - before the central bank announcement - at a record high. It has now risen 66 percent so far this year after a 130 percent leap in 2006.
The 0.5 percentage point increase in the reserve requirement ratio will take effect on August 15, the People's Bank of China said on its Web site, www.pbc.gov.cn. Big banks will then have to tie up 12.0 percent of their deposits instead of lending them out. The step follows an increase in interest rates on July 20 and a reduction in the tax on interest income from bank deposits, which was intended to give individuals less of an incentive to bet on the country's red-hot stock markets.
China's economy grew at a blistering 11.9 percent rate in the second quarter. It was the fastest pace in nearly 12 years and prompted authorities to warn about the risk of overheating. "The second quarter's stronger-than-expected GDP numbers have already pointed to the need for more tightening measures," said Qu Hongbin, chief China economist for HSBC in Hong Kong.
The central bank said the rise in required reserves was aimed at "strengthening management over liquidity in the banking system and controlling excessive growth in money supply and credit". The broad M2 measure of money supply grew 17.1 percent in the year to June, above the central bank's 2007 target of 16 percent. Economists say much of that expansion in liquidity is the result of the country's accumulation of foreign exchange stemming from its trade surplus, which hit a record $26.9 billion in June, and heavy inflows of investment.
To keep the yuan from rising too quickly, the central bank buys much of the foreign currency entering China. It has to print yuan in return, flooding the financial system with cash.
China's foreign exchange reserves were $1.33 trillion at the end of June, the largest in the world. "This is the continuation of the tightening policy that has been in place for some time, and has had particular momentum because of the much faster GDP growth that we have seen recently," said David Mann, currency strategist at Standard Chartered Bank in Hong Kong.
China has now raised the requirement six times in 2007. It has also raised interest rates three times so far this year. Economists say the latest move will lock up about 180 billion yuan ($23.8 billion) in cash that could otherwise have been lent out. It takes the ratio closer to the record high of 13 percent, which was in force from September 1988 until March 1998.
Economists expect the ratio to rise further. Royal Bank of Scotland is looking for two more half-percentage-point rises this year. Subbaraman expects the ratio to reach 13 percent by the end of 2008, while Mann sees it going as high as 14 percent. Required reserves tend to be set at low levels in mature countries and are changed only rarely, but lofty rates are not unusual in developing economies struggling with capital inflows.