China Raises Reserve Ratio to Curb Inflation as Zhou Pledges More to Come

China increased banks’ reserve requirements to lock up cash and cool inflation, and central bank Governor Zhou Xiaochuan said monetary tightening will continue for “some time.”

Reserve ratios will rise a half point from April 21, the People’s Bank of China said on its website yesterday, pushing the requirement to a record 20.5 percent for the biggest lenders. The move came less than two weeks after an interest-rate increase. Zhou sees no “absolute” limit on how high reserve requirements can go, he said April 16.

The nation’s fifth interest-rate increase since the financial crisis may come as soon as next month after inflation accelerated in March to the fastest pace since 2008, Societe Generale SA said. Chinese policy makers may also consider allowing faster appreciation in the yuan, described by the U.S. as “substantially” undervalued, to reduce the cost of imported commodities such as oil.

Higher reserve requirements “will help tighten monetary conditions and prevent banks from lending aggressively in the coming month,” said Liu Li-Gang, an Australia & New Zealand Banking Group economist in Hong Kong who formerly worked for the World Bank. Policy makers may also increasingly rely on the yuan to contain “imported inflation,” Liu added.

Geithner’s Case

The Shanghai Composite Index rose 0.4 percent as of 11:09 a.m. local time. Non-deliverable yuan forwards were little changed, indicating expectations for the currency to rise about 2.3 percent in the next 12 months from 6.5293 per dollar.

U.S. Treasury Secretary Timothy F. Geithner says a stronger Chinese currency would both counter inflation within the Asian nation and aid efforts to reduce economic imbalances that contributed to the global financial crisis.

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. Analysts’ median forecast is for the currency to climb to 6.3 per dollar by year end.

Speaking in Washington yesterday, PBOC Deputy Governor Yi Gang said the yuan is close to being freely usable, which would allow it to be included in the International Monetary Fund’s Special Drawing Rights basket. He said April 15 that a gradual appreciation of the currency would help his country overcome inflation.

Extra Liquidity

The IMF should consider adding the currencies of Brazil, Russia, India, China and South Africa into its SDR basket, which is a synthetic currency based on the dollar, euro, yen and pound, Yi told reporters. Group of 20 officials said after an April 15 meeting that they would study broadening the composition of the SDR and also currency misalignments.

A jump in the nation’s foreign-exchange reserves to $3 trillion in March highlighted an excess of cash in the economy. Extra liquidity from central bank bills maturing this month may have encouraged the fourth increase in reserve requirements this year. The move may drain 350 billion yuan ($54 billion) from the financial system, Bank of America Merrill Lynch says.

Shanghai’s stock index has climbed about 9 percent this year, compared with a 1.1 percent decline in the MSCI Asia Pacific Index, as investors bet that the government can tame prices without choking off the fastest growth of any major economy. In the first quarter, gross domestic product expanded a more-than-estimated 9.7 percent from a year earlier, a report showed last week.

‘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. “The trend will continue for some time.” He said that the government will “remove the monetary factors that are related to inflation,” echoing comments made by Premier Wen Jiabao.

The People’s Bank of China will raise interest rates twice more in the next 12 months, according to the cost to fix borrowing costs in the swap market. 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.

Overheating Pressures

The pace of China’s tightening highlights the divide with developed economies still struggling with sovereign-debt woes and elevated unemployment. The European Central Bank raised rates this month for the first time since the financial crisis, while Japan and the U.S. both have their benchmarks near zero.

The IMF said last week that Asian economies risk boom-bust cycles if officials fail to tighten quickly enough to curb “nascent overheating pressures.”

In China, inflation accelerated to a 5.4 percent annual pace in March, largely driven by food costs, a statistics bureau report showed three days ago.

The gain in consumer prices 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.”

Officials are 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.

Top Priority

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 the quarterly GDP numbers.

Wen aims to hold consumer-price gains 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.

“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. The 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.”

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

--Zheng Lifei, William Bi, Eva Woo, Feifei Shen, Belinda Cao, Winnie Zhu and Jin Jing. Editors: Paul Panckhurst, Andrew Blackman.

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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