Tags: AS | China | Banks

China Moves to Cool Overheating Economy

Monday, 03 May 2010 07:05 AM

China has ordered banks to raise the amount of money they hold in reserves for a third time this year in a new effort to dampen inflation pressures in the world's third-largest economy.

The measure, announced Monday, comes as the government tries to cool a credit boom without raising interest rates, which might slow China's economic rebound. Economic growth surged to 11.9 percent in the first quarter of the year and the government is trying to cool a surge in housing and other prices fueled by massive bank lending.

The People's Bank of China told banks to increase reserves by half a percentage point to 17 percent of their deposits for large institutions and 14 percent for most others.

The bank gave no explanation but analysts said it was trying to rein in rapid growth in China's money supply following an upsurge in inflows of speculative "hot money."

Such investors are hoping to profit from a rise in Chinese asset prices in foreign currency terms if Beijing loosens exchange rate controls and allows its yuan to gain against the dollar, which many expect in coming months.

The flood of money coursing through the economy pushed up politically sensitive housing prices by 11.7 percent in March over a year earlier.

"The government's campaign against property speculation is now center stage," said Mark Williams, of Capital Economics in London, in a report.

Beijing might increase bank reserves as often as once a month for the rest of the year while avoiding interest rate hikes until it sees how well the measure is working, Williams said.

"Today's decision should be seen accordingly as a normal part of the PBC's monetary management rather than as a signal of tightening to come," Williams said.

Regulators have been steadily tightening controls on lending by China's state-owned banking industry after it was ordered last year to step up credit to support Beijing's 4 trillion yuan ($586 billion) stimulus.

The latest move should drain some 320 billion yuan ($47 billion) from China's financial system, according to Tom Orlik, an analyst in Beijing for Stone & McCarthy Research Associates.

Orlik said he estimated inflows of "hot money" jumped to $40 billion in March, up from $8 billion in February and the highest level since April 2008.

China rebounded quickly from the global crisis while the United States and other major economies have lagged. That has made it more complicated for Chinese authorities to manage the strains of its fast-growing economy.

Analysts believe the People's Bank of China wants to avoid raising rates until the U.S. Federal Reserve does so, which Beijing would take as confirmation a global recovery is firmly under way. They say Beijing also worries that if it acts before the Fed, it might face an inflow of foreign speculative money hoping to take advantage of higher Chinese rates.

But the rise in housing and other costs is increasing pressure on Beijing to move.

"Producer and property prices have been increasing very quickly already and we believe it is just a matter of time before CPI inflation rises to higher levels," Goldman Sachs economists Yu Song and Helen Qiao said in a report.

"We believe further tightening measures will be needed to keep the economy from overheating," they wrote.

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