Bank takes further steps to soak up liquidity and control rising inflation

BEIJING - The required reserve ratios for banks were raised by 50 basis points on Friday - the ninth hike since the beginning of 2010 - to control inflation in the world's second-largest economy.

The measure will be effective from March 25, after which the reserve requirement ratio for large commercial banks will be 20 percent. It's estimated that the move will soak up about 350 billion yuan ($53 billion) from the market, said Li Xunlei, chief economist with Guotai Junan Securities.

"The current liquidity of the banking system is relatively abundant in the open market this month, with 700 billion yuan of funds due to return. But the uncertain international economic situation following the earthquake in Japan makes it difficult for the central bank to further raise interest rates, so it took the move to stabilize liquidity and curb inflation," said Guo Tianyong, an economist at the Central University of Finance and Economics.

China's consumer inflation rose to 4.9 percent in January and February from 4.6 percent in December. It hit 5.1 percent in November, a 28-month high. A drought in some major grain-producing areas, together with rises in international grain and oil prices, has led to growing concerns about rising inflation.

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To soak up excessive liquidity and help curb increasing inflation and asset bubbles, the central bank raised interest rates in February for the third time since October.

Lu Zhengwei, chief economist with the Industrial Bank, predicted the required reserves ratio for large lenders will probably reach close to 23 percent sometime this year, and interest rates might be raised three to four times before the end of the year. "But an interest rate hike is not likely to happen in March."

He said the central bank's move is a typically neutral measure to keep liquidity at a normal level while it adopts a wait-and-see attitude after the Japanese earthquake, and doesn't mean a continuous shrinkage of liquidity.

Huang Yiping, an economist at Peking University, said the moves to raise the deposit reserve requirement and interest rates since the beginning of the year demonstrate the government's resolve to check inflation.

"Now inflation is no longer my biggest concern. Instead, the risks of over-tightening are ahead. Once China tightens monetary policies too much, the economy will cool down and enterprises will suffer a lot, then the stance might have to become looser again in the next half-year," said Huang.

Some analysts said that a rise in the nation's foreign-exchange reserves, caused by the trade surplus, has increased liquidity in the domestic market and, in turn, put more pressure on inflation controls. By the end of 2010, China's foreign reserves amounted to a record $2.9 trillion.

Yu Yongding, a former adviser to the Chinese central bank, said at a conference on Friday that the central bank should stop intervening in the foreign-exchange markets and liberalize the yuan's exchange rate, to avoid increasing domestic liquidity pressures and a potentially large loss of foreign reserves in the future.