China Orders Banks to Raise Reserves to Cool Economy

Nov. 10 -- China ordered banks to put aside more reserves for the ninth time this year to cool an economy that expanded 11.5 percent in the third quarter and to damp speculation in stocks and real estate.

``To strengthen liquidity management in the banking system and curb excessive loan growth,'' lenders must set aside 13.5 percent of deposits from Nov. 26, the People's Bank of China said today on its Web site. The ratio, up from 13 percent, is the highest since at least 1987, according to Bloomberg data.

President Hu Jintao is trying to prevent boom turning to bust as a swelling trade surplus fuels stock prices, inflation and factory spending. The benchmark CSI 300 Index of stocks has soared about 147 percent this year.

``Increasing reserve requirements is the most efficient way to manage the excess liquidity coming from the trade surplus every month,'' said Frank Gong, chief China economist at JPMorgan Chase & Co. in Hong Kong. ``If inflation continues to surprise on the upside, the central bank may need to raise interest rates.''

Today's move will remove about 190 billion yuan ($26 billion) from the financial system. Local-currency deposits stood at 38.3 trillion yuan at the end of September.

Interest Rates

Besides raising the required reserve ratio, the central bank has also increased interest rates five times this year and sold bills to soak up cash from the financial system.

``Economic growth is certainly higher than the government wants to see,'' Liao Qun, chief economist at Citic Ka Wah Bank in Hong Kong, said before the announcement. ``They will push harder at macroeconomic tightening.''

Fixed-asset investment in urban areas climbed 26.4 percent in the first nine months from a year earlier, up from the 24.5 percent pace in all of 2006. Industrial production jumped 18.9 percent in September, the biggest gain in three months.

Premier Wen Jiabao says that the government will curb loans, tighten land use and restrict investment projects that lead to excessive capacity, pollution and energy consumption. He has also pledged to tackle inflation and house-price increases.

Inflation Expectations

In its quarterly report, the People's Bank of China said inflation will accelerate to about 4.5 percent this year from 1.5 percent in 2006, citing stronger inflation expectations and pressure from food, energy and labor costs.

Inflation of 6.2 percent in September was close to a decade high because of food-price gains. The rate exceeds the return on bank deposits and encourages households to switch savings into stocks and real estate.

Property prices in China's 70 biggest cities climbed 8.2 percent in the third quarter, according to the statistics bureau.

``A correction in the stock market would likely have a significant effect on the Chinese economy,'' said Daniel Melser, an economist at Moody's Economy.com, a unit of Moody's Investors Service in Sydney. ``China needs to urgently address the apparent overvaluation.''

China's trade surplus jumped 56 percent in September from a year earlier, taking it to $185.7 billion for the first nine months, more than the $177.5 billion record for all of 2006.

Money Supply

Money supply is surging because the government wants to hold down the yuan, forcing the central bank to sell the currency and pump cash into the financial system.

Money supply rose 18.5 percent in September, exceeding the official target of 16 percent for an eighth straight month.

``Measures so far have stopped growth from accelerating but haven't engineered a meaningful slowdown,'' said Michael Dai, an economist at Bank of China (Hong Kong) Ltd. ``China's economy is still facing excess liquidity and it needs ongoing tightening.''

China's economic growth slowed from 11.9 percent in the second quarter, the most in more than 12 years.

The government has resisted calls from the U.S. and Europe to let its currency strengthen at a faster pace, which would make imports less expensive and ease pressure on domestic prices as well as helping to curb the widening trade surplus.

U.S. Treasury Secretary Henry Paulson said this week that China is ``out of step'' with the rest of the world's calls to let the yuan appreciate.

The yuan has gained about 12 percent since the end of its peg to the U.S. dollar in July 2005.