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China Widens Reserve Ratio to Limit Inflation, Analysts Say

China broadened the base of reserves it requires commercial lenders to deposit with the central bank to control liquidity and limit inflation, economists said.

Reserve requirements are being extended to customers’ margin deposits, a move that may drain 900 billion yuan ($140 billion) from the banking system over six months, Bank of America Merrill Lynch economist Lu Ting said in an e-mailed note on Aug. 26. Mizuho Securities Asia Ltd. cited similar information. A central bank press official declined to comment.

China has already raised reserve ratios to a record 21.5 percent for the biggest banks to counter the fastest inflation since 2008. London-based Capital Economics Ltd. said that the reported move may mean no further increases this year, after previously anticipating another 1 percentage point gain by the end of December.

“It’s not surprising to see such a move from the Chinese government, as it is facing a big trade surplus and inflation pressure,” said Liu Li-Gang, a Hong Kong-based economist at Australia & New Zealand Banking group Ltd. “The move will further tighten liquidity,’” he said.

Industrial Profits

Premier Wen Jiabao aims to sustain the nation’s expansion while containing the risks from record credit growth. A 28 percent increase in industrial companies’ profits in the first seven months of the year, reported Aug. 27, suggests that businesses are weathering monetary tightening.

The central bank is clarifying the need to set aside reserves on margin deposits, Shen Jianguang, a Hong Kong-based economist at Mizuho Securities Asia, said on Aug. 27. While some banks already do so, the requirement hadn’t been clearly stated, he said.

The six largest Chinese banks need to start setting aside cash equal to as much as 21.5 percent of their margin deposits from Sept. 5, and complete reserves within three months, said Shen, citing information obtained from his investor contacts. Smaller banks will be given a requirement of 19.5 percent starting Sept. 15, with a five-month grace period, he said.

Spokesmen for China Construction Bank (939), Agricultural Bank of China, and Industrial and Commercial Bank of China, who declined to be named because of company rules, said they weren’t aware of the matter. Calls to a spokesman at Bank of China during the weekend weren’t answered.

Top Priority

Reserve requirements force commercial banks to park a proportion of their deposits with the central bank, reducing the amount of money available for lending.

Fighting inflation will remain the top priority in the second half of this year and monetary policy will remain “prudent,” the central bank said in its quarterly monetary policy report on Aug. 12. July’s 6.5 percent increase in consumer prices was the biggest since 2008.

Forcing lenders to set aside more cash may put “some upward pressure on interbank rates,” Bank of America’s Lu said. At the same time, the central bank can “neutralize” that effect by altering its program of bill sales, another tool for locking up cash, he said.

Lu calculated that the latest move may have an effect equivalent to a 130 basis-point increase in reserve requirements. Capital Economics’ estimate was “roughly 125 basis points.” One basis point is 0.01 percentage point.

The central bank has increased its reserve requirement ratio nine times since the second half of 2010, and raised interest rates five times during the period. The PBOC has held off for two months in boosting the ratio, the longest pause since the latest series of increases began in November.

Margin Deposits

Reuters reported Aug. 26 that reserve requirements will now cover margin deposits paid by banks’ clients to secure issuance of bankers’ acceptance, letters of guarantee and letters of credit. Such deposits were 4.4 trillion yuan ($689 billion) at the end of July, according to the report.

The net effect of the reported rule change “if everything else was unchanged,” would be to tighten monetary policy, Capital Economics said. “But in fact, we think any such move would be designed as an alternative to further reserve-requirement increases over the rest of the year.”

Policy makers are also monitoring the risks from the surge in lending that fueled the nation’s rebound from the global financial crisis. One focus is the credit that has been extended to local-government financing vehicles.

China’s five biggest banks posted first-half profits that surpassed the total of their 14 largest U.S. and European rivals, with Industrial & Commercial Bank of China Ltd. (601398) reporting last week that net income rose 29 percent to a record $17 billion.

--Helen Sun and Helen Yuan, with assistance from Tian Ying in Beijing and Winnie Zhu in Shanghai. Editors: Jim McDonald, Paul Tighe

To contact the reporter on this story: Helen Sun in Shanghai at hsun30@bloomberg.net

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

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