China’s Surplus Adds Liquidity as Inflation Risks Passing 5%

China’s rebounding trade surplus threatens to make it tougher for policy makers to contain consumer prices forecast to have climbed by the most in 27 months in November, approaching a 5 percent pace.

The excess of exports over imports was $22.9 billion last month, the government said yesterday, the fifth reading this year exceeding $20 billion. The influx of cash from trade has contributed to a 20 percent jump in money supply in the past 12 months, stoking liquidity in the fastest-growing major economy.

The central bank’s third increase in lenders’ reserve ratios in five weeks, announced yesterday, may be insufficient to rein in inflation, Credit Suisse Group AG said ahead of today’s report on consumer prices. The risk to Premier Wen Jiabao’s government of foregoing a rise in interest rates is an erosion of households’ purchasing power that impairs efforts to reduce the nation’s reliance on exports.

“China seems to have fallen behind the process of normalization,” said Dong Tao, chief regional economist for non-Japan Asia at Credit Suisse in Hong Kong. “The central bank is only keen to move on quantitative tightening, leaving interest rates little changed for fear of hot money inflows,” he said, referring to the potential lure for speculative funds.

A report scheduled to be released in Beijing today may show consumer prices rose at an annual pace of 4.7 percent, according to the median forecast in a Bloomberg survey of 29 economists, with seven seeing a pace of at least 5 percent.

‘Tilted to Overheating’

“The risk is tilted to overheating,” Stephen Schwartz, chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong, who used to work at the International Monetary Fund, said in an interview with Bloomberg Television. The central bank will need to raise borrowing costs four times by the end of next year to achieve a “soft landing,” ensuring economic growth of 9.2 percent, he said.

Yesterday’s 50 basis point increase in reserve requirements, effective Dec. 20, may lock up about 350 billion yuan ($53 billion), according to Barclays Capital Asia Ltd.

Exports rose 35 percent to $153.3 billion from November 2009 and imports advanced 38 percent to $130.4 billion, the customs bureau said yesterday. Both imports and exports reached record levels. The median estimate of 30 economists surveyed by Bloomberg News had been for a $21.2 billion surplus.

Separate figures yesterday showed that banks extended 564 billion yuan in new loans in November, leaving the year-to-date tally at just 50 billion yuan less than policy makers’ ceiling of 7.5 trillion yuan for all of 2010, according to data compiled by Bloomberg.

Case for Appreciation

Twelve-month non-deliverable yuan forwards rose 0.2 percent to 6.51 per dollar late yesterday, reflecting traders’ bets that the Chinese currency will appreciate 2.2 percent from the spot rate of 6.6556 in the coming year. Officials have let the yuan advance less than 3 percent this year.

“What really surprised me is how strong exports have been,” Wang Tao, a Beijing-based economist at UBS AG, told Bloomberg Television. “The case for China to appreciate the exchange rate is pretty strong,” she said, adding that appreciation of as much as 10 percent a year compared with less than 3 percent this year would “still be modest.”

Wang said she anticipates an interest-rate increase over the weekend. Economists surveyed by Bloomberg News this month anticipated a 1 percentage point rise in the benchmark one-year lending and deposit rates by the end of next year, according to the median forecasts. The central bank boosted both by a quarter point, to 5.56 percent and 2.5 percent respectively, in October.

Beijing Conclave

Communist Party leaders are meeting in Beijing to set guidelines for the economy in 2011 after the Politburo indicated Dec. 3 that officials will tighten monetary policy.

Commodities rose yesterday on the strength of Chinese demand and the absence of more aggressive tightening. The S&P GSCI index of 24 raw materials climbed 0.6 percent to 611.59 at 10:27 a.m. in London, led by advances in copper and cotton.

Without “firmer” measures such as rate increases and bigger gains in the yuan, “markets are unlikely to conclude that China will slow anytime soon,” said Kathleen Brooks, London-based research director at, a unit of online currency trading company Gain Capital.

China’s surpluses mean authorities need to buy dollars to limit the yuan’s gains, and the effort has yielded a record $2.6 trillion in foreign-exchange reserves so far. As authorities sell yuan for the dollars, they then need to mop up the domestic liquidity with bill sales. At the same time, demand for longer-dated debt has diminished on expectation of higher rates.

Bernanke’s Take

The People’s Bank of China refrained from offering three-year bills on Dec. 9, when it issued three-month bills, halting bi-weekly auctions of the longer-dated securities amid cooling demand from banks.

“China can’t have its own independent monetary policy” as long as it manages the exchange rate, Federal Reserve Chairman Ben S. Bernanke said in a excerpts of an interview released by CBS Corp.’s “60 minutes” program Dec. 5.

Persistent trade surpluses and a failure to allow faster appreciation in the yuan against the dollar also risks pushing U.S. lawmakers into passing protectionist legislation. Senate Foreign Relations Committee Chairman John Kerry said this week that Congress is growing impatient with China holding down the yuan and may impose legislation “with teeth” next year.

The Chinese currency gained 0.1 percent in November and 0.3 percent in October, compared with the 1.7 percent pace in September that U.S. Treasury Secretary Timothy F. Geithner signaled he sees as appropriate.

At the same time, U.S. government figures showed yesterday that China’s demand is helping propel American exports. The Commerce Department reported yesterday a $38.7 billion trade gap for October as shipments abroad reached a two-year high. China bought record amounts of U.S. products.

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