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China Raises Bank Reserve Ratios to Fight Inflation

China Raises Reserve Ratio by 50 Basis Points
A pedestrian walks past the People's Bank of China. Photographer: Nelson Ching/Bloomberg

China told banks to set aside more deposits as reserves for the fourth time in just over two months, stepping up efforts to rein in liquidity after foreign-exchange holdings rose by a record and lending exceeded targets.

Reserve ratios will increase 50 basis points starting Jan. 20, the People’s Bank of China said on its website today. One basis point is 0.01 percentage point. Interest rates were left unchanged.

Today’s move, adding to the Christmas Day interest-rate increase, underscores Premier Wen Jiabao’s determination to tame inflation that may trigger social unrest. Officials may front-load monetary tightening to the first half of the year after deciding to shift to a “prudent” monetary policy, according to JPMorgan Chase & Co. and Morgan Stanley.

“The overheating risk is real” and “the more authorities tighten, the more likely they can control inflation in the second half,” said Shen Jianguang, an economist at Mizuho Securities Asia Ltd. in Hong Kong. Still, “an interest-rate hike is more important and potent, so I believe another 25 basis point rate hike in January should be complementary.”

Shen estimates the reserve ratio will be raised by another 50 basis points in February.

Liquidity Drain

Today’s increase will lock up about 360 billion yuan ($54.6 billion) of liquidity, according to estimates from Barclays Capital economists, with Mizuho forecasting about 350 billion yuan.

Stocks in China tumbled today on concern monetary tightening may slow economic growth. The Shanghai Composite Index dropped 1.3 percent, bringing its loss over the past 12 months to 13 percent.

The reserve requirement now stands at 19 percent for the biggest banks, excluding any additional restrictions imposed on individual banks and not publicly announced.

China may boost reserve ratios by more than 200 basis points in 2011, according to HSBC’s Qu. Industrial Bank Co. economist Lu Zhengwei estimates the ratio may reach 23 percent.

China has lagged behind counterparts across Asia in taking steps to fight inflation as food and commodity costs climb in the wake of economic recovery in the region. Thailand raised its main rate for the fourth time in seven months on Jan. 12. The Bank of Korea executed its third such move since mid-2010 the next day. India’s central bank has lifted rates six times since March.

Rate Forecast

China needs to raise interest rates at least twice in the first half of this year to contain inflation, Qu Hongbin, a Hong Kong-based economist at HSBC Holdings Plc said today. The consumer-price index rose to a 28-month high of 5.1 percent in November and could jump by 5 percent to 6 percent in the first half, Qu estimated.

“The precondition for us to see inflation peak in the second quarter is that the government needs to act as soon as possible and more aggressively,” he told a briefing in Hong Kong.

Wen’s government is trying to mop up liquidity resulting from its policy of limiting currency appreciation and from surging inflows of capital from overseas. China’s foreign-exchange reserves climbed by $199 billion in the fourth quarter, to $2.85 trillion as of Dec. 31, the biggest quarterly gain since Bloomberg data began in 1996.

Banks extended 7.95 trillion yuan of new loans last year, exceeding the central bank’s target of 7.5 trillion yuan. Fitch Ratings estimates that figure excludes about 3 trillion yuan of loans banks have moved off their balance sheets to circumvent controls.

Money Supply

The central bank hasn’t officially released a lending or money supply target for this year.

China’s regulators aim to keep new loans at less than 800 billion yuan this month after they exceeded 500 billion yuan in the first seven days of the new year, the Economic Observer reported yesterday, citing a person close to the regulators. That compares with the 480.7 billion yuan of new loans extended in December.

The central bank may have acted now “to get ahead of the usual lending spree in January and February” and mop up liquidity from the large amount of central bank bills and notes that are due to mature, Yao Wei, an economist with Societe Generale Asia Ltd. said in a note. New lending, without any tightening, could hit 1 trillion yuan in January, Yao said.

Some 1.2 trillion yuan of bills issued through open-market operations fall due in the first quarter, according to Credit Agricole Cib estimates.

Inflation Concern

A survey released by the central bank in December showed Chinese consumers are more concerned about inflation than at any time in the past decade. Food costs climbed 11.7 percent in November from a year earlier, and Starbucks Corp. and McDonald’s Corp. are among companies to have announced price increases in the past two months.

Inflation will remain “relatively high” in the first half of 2011, especially in the first quarter, according to the National Development and Reform Commission. Zhou Wangjun, an official in the commission’s price department, was quoted by the official China Securities Journal today as saying authorities won’t rule out introducing further measures to control prices in the case of excessive inflationary pressure in the first quarter.

Monetary Tightening

China has boosted benchmark rates twice since the economy started recovering from the financial crisis, moving in mid-October and then on Christmas Day, as the government sought to rein in the credit boom that drove the rebound. In addition to bringing down inflation in food and consumer-goods prices, the government is trying to head off asset bubbles in real estate.

People’s Bank of China Governor Zhou Xiaochuan aims to slow expansion in money supply in 2011 in order to control price increases. The central bank is targeting 16 percent growth this year in M2, the broadest measure of money supply, after a 19.7 percent increase in 2010, people familiar with the matter said in December.

The central bank’s failure to soak up liquidity through its regular bill sales has strengthened the case for reserve-ratio increases, said Ken Peng, a Beijing-based economist at Citigroup Inc. The bank has sold 1 billion yuan of one-year bills at each of its last seven weekly auctions, the lowest since October 2007, according to Bloomberg data.

The reserve ratio “remains a cheaper and more high-profile move than open market operations for liquidity management,” JPMorgan Chase & Co. economists Qian Wang and Grace Ng wrote in a note today. The yield on one-year central bank bills is 2.7221 percent compared with a 1.62 percent rate paid on funds deposited for reserve requirement purposes, they said.

The central bank will use differentiated reserve ratios to improve liquidity management this year along with other tools including interest rates, official reserve ratios and bill sales, Governor Zhou said Jan. 4. The system involves setting separate requirements for lenders according to their balance sheets.

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