China orders Bank to raise Reserves

China ordered banks to set aside more deposits as reserves for the second time in a month to cool the fastest-growing economy after loan growth accelerated and property prices surged.

The reserve requirement will increase 50 basis points, or 0.5 percentage point, effective Feb. 25, the People’s Bank of China said on its Web site today. The current level is 16 percent for big banks and 14 percent for smaller ones.

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Stocks reversed gains in Europe after the announcement on concern that tighter lending in China will damp the global economic recovery. Policy makers aim to avert asset bubbles and restrain inflation after banks extended 19 percent of this year’s 7.5 trillion yuan ($1.1 trillion) lending target in January and property prices climbed the most in 21 months.

“This is all about controlling the boom, so that we don’t have a bust in the second half,” said Stephen Green, head of China research at Standard Chartered Bank Plc in Shanghai.

The central bank moved after Chinese markets closed and on the eve of a weeklong Lunar New Year holiday when the nation moves into the Year of the Tiger from the Year of the Ox. Europe’s Dow Jones Stoxx 600 Index and commodities fell. The Shanghai Composite Index rose 1.1 percent before the announcement.

Record lending and a 4 trillion yuan stimulus package have helped the nation to lead the recovery from the first global recession since World War II.

Avoiding ‘Overheating’

“With China’s increasing economic significance in the world economy, major policy moves will always touch a nerve with global markets,” said Qu Hongbin, chief China economist at HSBC Holdings Plc in Hong Kong. “Still, timely tightening in China will help sustain growth and avoid overheating, benefiting the world in the long term.”

Investors’ concern about investment bubbles in China, and what action the government may take to prevent or deflate them, has mounted this year.

“There’s a monumental property bubble and fixed-asset investment bubble that China has underway right now,” hedge fund manager James Chanos, founder of New York-based Kynikos Associates Ltd., said in a Jan. 25 Bloomberg Television interview. “Deflating that gently will be difficult at best.”

The central bank said yesterday that it wanted to gradually normalize monetary conditions from a “crisis mode” after gross domestic product grew 10.7 percent in the fourth quarter, the fastest pace in two years. It also said that not all countries will exit stimulus policies at the same time.

Pegged Currency

Policy makers are yet to drop the yuan’s effective peg to the U.S. dollar, which was adopted in July 2008 to aid the nation’s exporters, stoking friction with the U.S. and Europe.

Credit Suisse Group AG. estimated that today’s move will remove about 300 billion yuan from a financial system also facing inflows of cash from investors betting on the nation’s recovery and likely gains by the yuan. The nation’s foreign- exchange reserves swelled to a record $2.4 trillion in December, partly on inflows of “hot money,” or speculative capital.

“The central bank will keep raising the ratio frequently until the middle of the year,” said Lu Zhengwei, a Shanghai- based economist at Industrial Bank Co., who predicted today’s increase. “The central bank wants to stay ahead of the curve by tightening before inflation starts to gain pace.”

He forecast an increase in the benchmark lending rate from 5.31 percent as early as April.

In contrast, Citigroup Inc. said the central bank may not raise rates until the third quarter as inflation stays “mild.”

Weaker Inflation

Consumer prices rose 1.5 percent in January from a year earlier, down from 1.9 percent in December, on smaller gains in food prices. Inflation will accelerate to 3.6 percent by the end of June, according to a Bloomberg News survey of economists.

“Raising the reserve ratio on the eve of the Chinese New Year holiday really makes a lot of sense as it will give markets time to react,” said Mark Williams, an economist at Capital Economics Ltd. in London.

Economic data this week showed property prices across 70 cities surged 9.5 percent in January from a year earlier, exports climbed and producer-price inflation accelerated. Bank lending of 1.39 trillion yuan topped the total for the previous three months combined.

The central bank on Jan. 12 increased banks’ reserve requirements for the first time since June 2008. The latest move will soak up liquidity from maturing central-bank bills and also money injected into the financial system for the coming holiday, China International Capital Corp. said.

At Morgan Stanley, Hong Kong-based economist Wang Qing said that today’s increase would counter foreign-exchange inflows which “must have been persistently strong since January” and also withdraw money added for the holiday.

Reserve-requirement increases will continue through 2010, Wang said. “The market should get used to it.”

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