China's central bank said on Friday 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. The People's Bank of China said it would increase required reserve ratios by 50 basis points. The fifth such move to be announced this year, it takes required reserves to 18.5 percent for big banks, a record high.
The central bank said the increase was intended "to strengthen liquidity management and appropriately control money and credit issuance". The increase takes effect on November 29. The move was not a surprise and, in fact, could be something of a relief for investors who had expected worse.
"The second RRR hike in two weeks 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 on aggressive monetary tightening." 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 crystallised when China's cabinet vowed on Wednesday to take "forceful" measures, including price controls if necessary, to rein in inflation. China raised interest rates on October 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 driving up Chinese inflation. The 50 basis point RRR increase 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 US and European recoveries remain fragile.
In addition to increasing required reserves, China has also issued strict orders to banks to curtail their lending. Chinese policy makers have blamed monetary easing in the United States for propelling cash towards 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 unprecendent credit surge and the government has been slow to mop up the money still cascading over the economy.