China Reserves Raised, Inflation Is Target

Conference concludes with monetary policy shift as special RRR is extended for six banks

In the wake of a bank reserve hike on Friday, the Central Economic Work Conference in China, chaired by President Hu Jintao, ended Sunday with the issuance of a policy statement that shifts toward fighting inflation. On Monday that strategy shifted into high gear with the extension of a special increase in reserve requirement ratio (RRR) for six of China’s biggest lenders.

Reuters reported that the country is moving toward promotion of domestic consumption as a hedge against falling exports. Leaders said they would cap banking system liquidity and steer more bank loans into the real economy in the wake of inflation that in November rose to a 28-month high and seemed poised to move beyond food prices.

While exports have not fallen—in fact they jumped 34.9% in November from November of 2009—concerns over a drop in consumption in the rest of the world have fueled China’s policies. Chinese imports have also skyrocketed, gaining 37.7% in November compared with November of 2009.

The 50-basis-point hike in the RRR on Friday brings the reserve requirement rate for China’s banks to 18.5%, which is a record for many of its banks. This was the third RRR increase in a month, and there are expectations that more will follow; Lu Zhengwei, chief economist at Industrial Bank in Shanghai, said, “There is still much scope for the central bank to raise reserve ratios next year—we expect several increases in the first quarter of next year and the ratio should reach as high as 23 percent in 2011.”

The special RRR extended on Monday had been put into place in October, and its extension serves as a holding measure, according to Reuters, while more aggressive strategies are considered. The six banks affected, which include China Commercial Bank (0939.HK) and Industrial and Commercial Bank of China (1398.HK), must keep their reserves at a record 19%, tying up some 180 billion yuan ($27 billion) that they could otherwise lend.

There are also indications that another interest rate hike may occur in the months to come to help ward off inflation. China may also be under increasing pressure to value the yuan higher thanks to a trade surplus of $22.9 billion in November, the seventh straight month of strong performance; the surplus has averaged $22.2 billion for the past seven months.

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