China Tells Banks to Boost Reserves as Prices Surge

China increased banks’ reserve requirements to lock up cash and limit inflation after economic growth exceeded forecasts and consumer prices rose by the most since 2008.

Reserve ratios will rise a half point from April 21, the People’s Bank of China said in a one-sentence statement on its website today. The move, taking the requirement to 20.5 percent for the nation’s biggest lenders, came less than two weeks after the central bank boosted benchmark interest rates.

Inflation accelerated to 5.4 percent in March and gross domestic product expanded 9.7 percent in the first quarter, a statistics bureau report showed two days ago. Central bank Governor Zhou Xiaochuan said yesterday that monetary tightening will continue for “some time” and he sees no “absolute” limit on how high reserve requirements can go.

“Beijing did not take long to respond to the strong inflation number on Friday,” said Brian Jackson, an emerging markets strategist at Royal Bank of Canada in Hong Kong. “Today’s move suggests that another increase in interest rates is on the way soon.” He predicts two more rate moves this year, calling Zhou’s tone “hawkish.”

Extra liquidity from central bank bills maturing this month may have encouraged the fourth increase in reserve requirements this year. Today’s move may drain about 350 billion yuan ($54 billion) from the financial system, according to Bank of America Merrill Lynch.

‘Overheating Pressures’

Premier Wen Jiabao aims to cool inflation without choking off growth in the world's second-biggest economy. The International Monetary Fund says Asian economies risk boom-bust cycles if officials fail to tighten quickly enough to curb “nascent overheating pressures.”

China is grappling with the aftermath of a record 17.5 trillion yuan of lending over 2009 and 2010 that drove up property prices, leading to official concern at the risk of social discontent. Taming inflation is the government’s top and “urgent” priority, China’s cabinet said after meeting in Beijing to review the performance of the world’s second- biggest economy ahead of the release of gross domestic product numbers.

Wen aims to hold inflation at 4 percent for the full year. While rising commodity costs are adding to price pressures, tightening measures and comparisons with higher year-earlier bases are likely to slow price gains in the second half of the year, according to HSBC Holdings Plc.

‘Prudent’ Policy

“Our monetary policy will continue to move from moderately loose to prudent,” Zhou said at a briefing in the southern Chinese province of Hainan, where he attended the Boao Forum for Asia. He said that the government will “remove the monetary factors that are related to inflation,” echoing comments made by Wen.

Tao Dong, a Hong Kong-based economist for Credit Suisse Group AG, said today that he had doubts about how much further the central bank could raise the reserve ratio.

U.S. officials may hope that China instead increasingly relies on currency appreciation. Treasury Secretary Timothy F. Geithner calls the yuan “substantially undervalued” and says that a stronger currency would both counter inflation pressures in China and aid efforts to reduce global economic imbalances.

Currency Gains

The yuan has gained about 4.5 percent against the dollar since June last year, when China scrapped a crisis policy of keeping the currency unchanged against the greenback. The yuan closed at 6.5325 per dollar in Shanghai on April 15.

Inflation is “definitely” a problem, China International Capital Corp. Chief Executive Officer Levin Zhu told reporters at the Boao Forum. “Money supply and inflation problems are quite worrying. The government can weaken inflation by controlling money supply.”

The most recent rate increase, effective April 6, took key one-year borrowing costs to 6.31 percent and the deposit rate to 3.25 percent. While higher rates can attract “hot money,” or speculative capital, the size of the Chinese economy means that such inflows are not always a problem, according to Zhou.

China’s four interest-rate increases since the global financial crisis compare with the European Central Bank moving for the first time this month. Benchmark rates remain near zero in the U.S. and Japan, highlighting Asia’s role in leading the economic recovery.

A surge in foreign-exchange reserves to $3 trillion last month and rebounding lending and money-supply growth highlighted overheating risks. At the same time, government controls have pulled credit growth back from the record levels of 2009.

--Zheng Lifei, William Bi, Eva Woo, Feifei Shen, Winnie Zhu, and Jin Jing. Editors: Paul Panckhurst, Richard Dobson.

To contact Bloomberg News staff for this story: Lifei Zheng in Beijing at +86-10-6649-7560 or lzheng32@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at ppanckhurst@bloomberg.net

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