China hikes bank reserve ratio to halt loan rush

BEIJING: China ordered banks to set aside more money as reserves for the third time this year to curtail a credit-fuelled investment boom that may cause the world’s fastest- growing major economy to overheat.

Banks must set aside 9% of deposits as reserves starting November 15, up from 8.5%, the Beijing-based People’s Bank of China said on Friday on its website. The move will cut the amount of money they have available for lending.

China, which has raised interest rates twice since April, wants to prevent cash generated by a record trade surplus from funnelling into investment projects. Premier Wen Jiabao vowed on October 18 to keep controls on lending to cool a spending binge the World Bank warns could lead to overcapacity and falling profits.

“The liquidity inflow situation is too much for the central bank to handle,” said Liang Hong, an economist at Goldman Sachs in Hong Kong. “This won’t be the last time that China tightens monetary policy.”

China, the world’s third-largest exporter, had its second- largest trade surplus on record in September, taking the total for the first nine months to $110bn and topping last year’s total. The nation’s ministry of commerce forecasts the gap may reach $150bn this year.

“There’s a ton of liquidity hitting the banking system in the next couple of months because China’s trade surplus usually rises toward the end of the year,” said Stephen Green, a Shanghai-based economist with Standard Chartered Bank. The swelling surplus is boosting China’s foreign exchange reserves, which have doubled in the past two years.

At the end of September the nation’s holdings stood at $988bn, making them the world’s largest, as the central bank bought foreign currency to prevent the yuan from rising. The People’s Bank of China hasn’t been able to mop up all the yuan it’s issued in exchange for the currency, providing newly recapitalised banks with a surfeit of funds to dole out for new projects.

Investment in China has been rising at almost triple the pace of overall growth since ’03, a rate the government calls unsustainable. Expansion in spending of more than 25% a year has led to a “huge increase in capacity” that’s aggravating problems of excess production, the ministry of commerce said this week.

Friday’s increase came 11 weeks after the central bank raised benchmark lending and deposit rates simultaneously for the first time in two years. It also lifted the lending rate in April. Banks’ reserve ratio requirement was increased in July and August, by a half-point each time.

The moves have been accompanied by a series of administrative curbs on new project approvals and land use aimed at slowing investment growth. Authorities in Inner Mongolia said last month they cancelled 43 new investment projects in the first half of the year, without specifying which ones.

“There has been some moderation in excess liquidity,” the central bank said in its statement. “But there’s still too much liquidity in the banking system.” Without allowing more flexibility in the yuan, which will allow the currency to rise faster, the central bank won’t succeed in choking off the flow of funds into the banking system.

“The bank is trying to dampen liquidity so this move makes sense,” said Julian Jessop, chief international economist at Capital Economics in London.

“It still doesn’t solve the fundamental problem of excess liquidity, which will remain as long as China maintains these huge trade surpluses.”

By letting the yuan strengthen, exports would become more expensive and imports cheaper, helping to slow the surplus. Faster yuan gains would also appease trading partners such as the US who accuse the nation of keeping its currency undervalued to support exports.

“Faster appreciation of the yuan has to be part of the policy package,” said Qing Wang, head of Greater China research at Bank of America in Hong Kong. The yuan was revalued by 2.1% against the US dollar on July 21 last year and the government caps the currency’s daily movements against the dollar at 0.3% either side of a daily reference rate. The yuan has since dropped almost 1 percent against the euro while rising 3% against the dollar.