China takes fresh steps to stem bank lending

The Chinese authorities took fresh steps to rein in bank lending yesterday, warning that there was "excessive" liquidity in the world's fastest-growing economy.

The People's Bank of China said that from Monday big state banks and joint-stock banks must hold 9.5 per cent of their funds in reserve, up from 9.0 per cent, while smaller banks must lock up 10 per cent in their vaults.

Analysts said the move should stem the fall in the market interest rates on the back of the growth in money supply, but said it was unlikely to put the brakes on the rise in credit.

"This might raise fears that further monetary tightening will make a 'hard landing' more likely, but we think that such fears are overdone," said Julian Jessop, chief international economist at Capital Economics.

He said it was the latest in a sequence of increases in the reserve requirement, which the PBoC saw as preferable to simply raising interest rates. "That would penalise those investment decisions that are being made on economic criteria, without necessarily discouraging state banks from lending for non-economic projects," he said. "We would see today's announcement as making another increase in benchmark lending rates less likely, rather than more."

Rob Subbaraman, senior economist with Lehman Brothers, said: "I think they are using it as a primary tool to absorb excess liquidity which is building up from large trade surpluses and capital inflows."

China's massive balance of payments surplus has been largely generated by a rapidly growing trade surplus, which hit $22.9bn in November and is expected by many economists to top $175bn in 2006, up from $102bn in 2005, when it trebled.

The move will do nothing to reduce demands by countries such as the US on Beijing to allow the value of the currency to rise. They say that is a better way of helping to cut the trade surplus, thus turning off the valve of liquidity at the source.

Glenn Maguire, Asia Pacific chief economist at Société Générale, said: "Lifting the reserve requirement ratio and the increased issuance of sterilisation bills will continue to be ineffective in the absence of a faster pace of yuan appreciation."

The decision to use reserve requirement rather than monetary policy showed that Beijing was more interested in curbing domestic inflation than reducing its trade surplus, Mr Jessop said. "Put another way, it is best seen as a case of the authorities taking the foot off the accelerator rather than slamming on the brakes."