China Tells Banks to Raise Reserves to Cool Economy (Update3)

Dec. 8 -- China ordered banks to increase reserves by the most in four years to try to prevent the world's fastest-growing major economy from overheating.

Lenders must put aside 14.5 percent of deposits as reserves, starting Dec. 25, up from the previous 13.5 percent, the People's Bank of China said today on its Web site. The ratio is the highest since at least 1987 when the data began and the increase is twice as much as the nine others this year.

The decision comes before a visit to Beijing next week by U.S. Treasury Secretary Henry Paulson, who said Dec. 5 that China's government should allow the yuan to appreciate at a faster pace to reduce the nation's record trade surplus. China's surging exports are pumping cash into the financial system, fueling inflation and concern the economy will overheat.

The larger-than-usual increase ``reflects the urgency of inflation concerns of the government,'' said Liang Hong, an economist at Goldman Sachs Group Inc. in Hong Kong. ``The move will help strengthen the credibility of the central bank and anchor inflationary expectations.''

Today's move will take about 380 billion yuan ($51 billion) out of the banking system. Local-currency deposits stood at 37.9 trillion yuan at the end of October.

Chinese leaders and officials, during a three-day annual economic work conference this week, highlighted economic overheating and ``evident'' inflation as key risks for 2008, after the world's fourth-largest economy expanded more than 11 percent over the past three quarters.

``The increase is in line with a tightening monetary policy after the central economic working conference, and aims to strengthen liquidity management and curb overly fast credit growth,'' the central bank said in the statement today.

Trade Partners

Paulson has argued a stronger yuan would slow the expansion of China's trade surplus and reduce tension with international trading partners.

``A more flexible currency is especially important now, when the risks of inflation are clearly rising,'' Paulson said in a speech in Washington this week. A stronger currency would lower the price of imported goods such as iron ore, oil and grain. It would also help to staunch the flow of money into the economy by pushing up export prices.

The yuan has gained 12 percent against the U.S. dollar since abandoning its peg in July 2005 and fallen 8 percent versus the euro.

``The best way for China to deal with its current economic problems and manage excess liquidity would be to allow faster currency appreciation,'' said Wang Qian, an economist at JPMorgan Chase & Co in Hong Kong.

Higher Prices

China's consumer prices jumped 6.5 percent in October from a year earlier. Inflation is accelerating because of higher food, energy and labor costs.

Faster inflation makes it harder for the government to prevent asset bubbles because people would rather put money in stocks or property than leave it in the bank to lose value. Household savings fell by 506.2 billion yuan in October from September.

Today's ``more aggressive tightening will likely put downward pressure on China-related assets in the short term,'' Goldman's Liang said.

The key CSI 300 Index of shares has climbed 147 percent this year even after declines since mid-October. House prices in 70 major cities jumped 9.5 percent in October from a year earlier, the biggest increase since records began in August 2005.

The People's Bank of China has raised interest rates five times this year, boosting the key one-year lending rate to 7.29 percent, the highest since 1998, and the deposit rate to 3.87 percent.

Curb Lending

It also sells bills to drain cash from the financial system and has instructed banks to curb lending.

``The big increase in the reserve ratio suggests the start of a tightening monetary policy,'' said Lian Ping, chief economist at Shanghai-based Bank of Communications Ltd.

The banking regulator will set a stricter cap of 13 percent on commercial lenders' loan growth in 2008, down from the 15 percent target this year, the China Business Journal reported on Dec. 3.

``Raising reserve requirements to control liquidity is easier and less expensive'' than selling bills, Sun Mingchun, an economist at Lehman Brothers Holdings Inc., said before today's decision. ``The cost is its bad effect on bank profitability.''

The central bank pays 1.89 percent interest on the reserves it requires banks to set aside.

Target Breached

Money supply grew 18.5 percent in October from a year earlier, breaching the central bank's annual target of 16 percent for the ninth straight month.

Banks have extended 3.5 trillion yuan of new loans so far this year. Seven banks including Agricultural Bank of China are banned from making new loans this year, the official Shanghai Securities News reported Nov. 29.

Loan growth, soaring company profits and cash raised in buoyant stock markets have fueled an acceleration in factory and property spending.

Fixed-asset investment in urban areas increased 26.9 percent through October from a year earlier. That was up from 24.5 percent in all of 2006 and raises the likelihood of idle factories and bad loans in a slowdown.