China Reserve-Ratio Hike Doesn't Alter Positive Stocks Outlook, RBS Says

China’s bank reserve-ratio increase doesn’t change the “quite positive” outlook for the nation’s stocks, which will be boosted by the expanding economy and improving earnings, said Royal Bank of Scotland Group Plc.

China’s central bank told lenders on Jan. 14 to hold more deposits as reserves for the fourth time in two months, lifting required ratios by half a percentage point. The benchmark Shanghai Composite Index slumped 1.3 percent to a two-week low prior to the announcement, which came after the market close. The measure slid 3 percent to 2,706.66 at the 3 p.m. close today.

“Rising rates are more illustrative of a more robust growth outlook while rising inflation spurs nominal earnings,” said Emil Wolter, Singapore-based head of Asian regional equity at RBS. “The market will likely take this move in its stride.”

The world’s fastest-growing major economy will expand 8.7 percent in 2011, compared with a forecast 10 percent last year, as the government tries to limit increases in asset prices and unwinds fiscal stimulus, according to the World Bank. “Too rapid growth” is one of the biggest risks to the economy this year, Yao Jingyuan, chief economist at the National Bureau of Statistics, said yesterday.

China is grappling with accelerating inflation pressures as food and commodity costs climb and liquidity rises with an influx of foreign capital. The nation’s inflation rate jumped 5.1 percent in November, the fastest in 28 months, while foreign-exchange reserves soared by $199 billion last quarter, the most since data compiled by Bloomberg began in 1996.

Reserve Ratio

“Excess liquidity” in the economy is rising through “accelerating money supply” and foreign-exchange reserve growth, Wolter said in response to e-mailed questions. “These indicators have strong positive correlations with share prices.”

M2, the broadest measure of money supply, rose 19.7 percent last month, the central bank said Jan. 11. That exceeded the median estimate of 19 percent, according to economists surveyed by Bloomberg.

Investors should reduce their positions in China’s stocks and buy consumer companies that are less dependent on economic growth as the government continues to tighten, according to Shenyin & Wanguo Securities Co. The central bank will probably increase the reserve-ratio requirement and raise interest rates next month as inflation quickens, analyst Yuan Yi said.

Premier Wen Jiabao’s government has lagged behind other Asian countries in raising benchmark lending rates, with two quarter-point increases since October. Officials have instead relied on reserve ratios to try and mop up liquidity resulting in part from trade surpluses and inflows of foreign capital.

‘Overweight’ Allocation

The reserve requirement stood at 18.5 percent for the biggest banks before last week’s announcement, excluding any additional restrictions imposed on individual banks and not publicly announced. The one-year lending rate is 5.81 percent.

Wolter had an “underweight” allocation for Chinese stocks for the first 10 months of last year. He increased his weighting to “overweight” on Oct. 14 on the prospect a global “liquidity wave” would boost equities.

The Shanghai gauge plunged 14 percent in 2010, the worst performer among the 10 biggest benchmark indexes globally, on concern government tightening measures would slow economic growth and hurt earnings. The gauge has lost 3.6 percent this year.

--Allen Wan, Zhang Shidong. With assistance from Zheng Lifei, Li Yanping. Editors: Richard Frost, Reinie Booysen

To contact Bloomberg News staff for this story: Allen Wan in Shanghai at +86-21-6104-3041 or awan3@bloomberg.net

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net

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