May 12, 2011

China Raises Reserve Ratios Despite Slowing Economy

Lifts requirements by 50 basis points to target inflation

China announced Thursday that it was raising its reserve requirement ratio (RRR) once again, despite indications that its economy was slowing down. Inflation is still rising and the central bank is focusing on that, hoping to forestall possible civil unrest that could result from too much of an increase in the prices of such essentials as food.

Reuters reported that the RRR was increased by 50 basis points to a record 21%, and the increase will take effect on May 18, according to the central bank's website. The increase is the eighth since October, and follows Wednesday's report that April's inflation figure came in at 5.3%, considerably higher than the Chinese government's target of an average of 4% for the year.

The central bank took the action despite additional data that showed an unexpected and considerable slowing in the Chinese economy, with factory output down more than was expected. It also sold 40 billion yuan ($6.2 billion) of 3-year bills on the open market on Thursday to absorb as much excess cash as possible and prevent it from contributing to additional inflation.

Xu Biao, an economist with China Merchants Bank in Shenzhen, was quoted in the report saying, "The central bank is moving the deposit reserve ratio again to soak up liquidity as hot money inflows and current account surplus remain large."

Analysts polled in April expected the RRR to be increased again to 21.5% by the end of December. It looks likely that that target will be met much earlier than they anticipated, barring a slowing of inflation in China, but that seems unlikely. More cash is anticipated to enter China in months to come from foreign direct investment, China's massive trade surplus, and maturing central bank bills and repos.

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