China moves to tighten credit amid fears of overheating

China yesterday tightened its grip on credit in an attempt to prevent the torrent of cash generated by its ballooning trade surplus from overheating the economy.

In a surprise announcement on the eve of the Chinese new year holidays, the People's Bank of China ordered lenders to park another half a per cent of their deposits at the central bank instead of lending the money out.

From 25 February, when the week-long holiday comes to an end, the big banks will have to put 10 per cent of their deposits in reserve, while the figure for smaller banks rises to 10.5 per cent. India unveiled a similar change in policy earlier this week.

The announcement of the move - the fifth such tightening since last June and the second this year - came a day after the central committee of the ruling Communist Party said that controlling investment and credit growth would be a key policy task this year.

Explaining its decision, the central bank said: "We need to raise the bank reserve requirement ratio (RRR) again, according to dynamic changes in the liquidity situation so as to cement the effects of the macro controls."

Shockwaves were felt in London, with mining stocks, including Vedanta Resources, Rio Tinto, Antofagasta and Kazakhmys, falling sharply as traders judged the tightening would hit commodity prices.

"If it's pointing to slightly slower growth in China, you would have expected an impact on commodity prices. Obviously, China is a very big consumer of commodities," said Robert Parkes, UK equity strategist at HSBC.

The move is aimed at mopping up excess banking liquidity to prevent the boom in the world's fourth biggest economy from turning to bust. Money is pouring into the banking system from China's enormous trade surplus, which hit a record $177.47bn (£91bn) last year.

The central bank has also raised interest rates twice since last April, ordered banks to rein in lending to specific sectors and stepped up the sale of bills and bonds to take cash out of circulation.

In addition to long-standing worries that easy credit could fuel a resurgence in investment that could lead to supply gluts and bad bank loans, policymakers are concerned that firms and individuals are borrowing freely to punt on the stock market. Reports suggest that up to 90 per cent of all personal loans are being funnelled into equities.

The Shanghai bourse soared by 130 per cent last year, making it the world's best-performing major market.The central bank is worried about the impact on small investors if share prices collapse.

Analysts questioned the effectiveness of the latest move, however. Richard Yetsenga, currency strategist at HSBC in Hong King, said: "The fundamental problem hasn't changed. China continues to get about $15bn in new domestic credit creation every month, which is far too much."

Hong Liang, an economist at Goldman Sachs, said: "We maintain our view that the RRR change is a blunt and inefficient tool for conducting monetary policy.

"The past four years' experiences in China have shown that its effectiveness tends to erode very quickly by continued inflows of foreign exchange driven by the undervalued currency."

China's breakneck expansion - it clocked up its fourth successive year of double-digit growth last year - is not without its problems for the rest of the world. Its seemingly insatiable appetite for capital spending on factories and machinery has pushed up commodity prices around the globe, fuelling inflation. And G7 finance ministers and central bank chiefs have long called on Beijing to relax its iron grip on the yuan and allow it to rise on foreign exchanges.