China’s Central Bank May Push Up Reserve Ratios, Adviser Li Says

People's Bank of China Adviser Li Daokui
China will raise benchmark interest rates only slowly and won’t “slam on the brakes” as the nation officially switches to a tighter monetary policy, said Li Daokui, an academic adviser to the central bank. Photographer: Nelson Ching/Bloomberg

China may order higher reserve requirements for banks to counter capital inflows and a possible jump in lending at the start of 2011, said Li Daokui, an adviser to the central bank.

Li was commenting on the Communist Party Politburo announcement that the nation will move next year to a “prudent” monetary policy from the current “moderately loose” stance. The statement, which endorsed a continued “proactive” fiscal policy, was reported by the state-run Xinhua News Agency.

Boosting reserve requirements would counter inflows of money and “China’s own economic cycle, such as the fact that banks tend to lend more at the beginning of a year,” Li said in a phone interview in Beijing yesterday.

China already has been winding back stimulus to rein in liquidity and combat accelerating inflation. Inflows of capital to Asia, the region leading the global recovery, threaten to fuel price gains and asset bubbles.

“Interest rates will be adjusted over the next year, but the process will be gradual and slow and take into account various factors including global conditions,” said Li, who is the head of Tsinghua University’s Center for China in the World Economy. “A monetary policy shift won’t happen overnight.”

Li has a Ph.D. in economics from Harvard University and worked at Stanford University’s Hoover Institution.

Crisis Policy

The People’s Bank of China raised lending and deposit rates in October for the first time since 2007, lifted banks’ reserve requirements with five publicly announced increases this year, and has restricted loan growth. The one-year lending rate is at 5.56 percent, while the deposit rate is 2.5 percent. Li didn’t give a specific forecast for rate moves.

Officials also in June ended a crisis policy of pegging the nation’s currency to the dollar. The yuan can strengthen at a faster pace if gains are controllable, Li said, adding that appreciation would help to ease inflation and aid economic rebalancing.

The nation lags behind counterparts from Malaysia to South Korea in boosting borrowing costs. South Korea has raised rates twice this year, Malaysia three times and India six. Thailand’s unexpected increase this week was the nation’s third in 2010.

China has a sound base for stable and fast growth next year even as difficulties and challenges remain, the Politburo said yesterday, adding that the government will ensure food supplies and stabilize prices.

‘Imminent’ Move

The government was last using the term “prudent” for monetary policy in 2007 before shifting to a tighter stance as overheating risks increased before the financial crisis.

“Rate hikes are imminent -- we expect one by the end of the month, with more to come in 2011,” Brian Jackson, a Hong Kong-based emerging-market strategist at Royal Bank of Canada, said after the Politburo statement.

The Shanghai Composite Index, which tracks the bigger of China’s stock exchanges, slipped 1.2 points, or less than 0.1 percent, to 2,842.43 at the 3 p.m. local-time close yesterday, after the statement.

China’s next rate increase may be on Dec. 10 and the yuan may strengthen at a “slightly” faster pace before year-end, said Shen Jianguang, a Hong Kong-based economist at Mizuho Securities Asia Ltd. who formerly worked for the International Monetary Fund and the European Central Bank.

Lending Curbs

Economists, including at Morgan Stanley, expect the government to trim the nation’s lending quota again next year. Inflation pressures have been highlighted by companies including McDonald’s Corp., the world’s largest restaurant chain, pushing up prices.

At Bank of America-Merrill Lynch, economist Lu Ting said yesterday that continuing a “proactive” fiscal stance while tightening monetary policy will allow the government to maintain economic growth of around 9 percent. The expansion was 9.6 percent in the third quarter from a year earlier.

According to Li, fiscal policy will remain “very expansionary” with the budget deficit staying about 3 percent of gross domestic product.

October’s inflation rate of 4.4 percent was the highest in 25 months and the nation has had record property-price gains this year. Luxury-home costs in Beijing and Nanjing and so-called mass-market prices in Shanghai and Shenzhen have become “increasingly disconnected from fundamentals,” according to an International Monetary Fund study released yesterday.

The announcement from the Politburo, the 25-member body that oversees the Communist Party and policy-making, came ahead of an annual economic work conference that will set guidelines for the coming year. That event may take place Dec. 10-12, Xinhua said yesterday.

Concern that monetary tightening will cut corporate profits and damp growth spurred a 6 percent sell-off in China’s benchmark stock index in the past month.

The announcement of a “prudent” stance had been predicted by economists including at Deutsche Bank AG. and China International Capital Corp. Central bank officials and advisers had also used the term.

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