China Requires Banks to Set Aside Bigger Reserves (Update2)

By Nipa Piboontanasawat

Oct. 13 (Bloomberg) -- China ordered banks to set aside more money as reserves for the eighth time this year to cool speculation in stocks and real estate and curb the fastest inflation in 10 years.

Lenders must park 13 percent of deposits as reserves from Oct. 25, up from 12.5 percent, the People's Bank of China said today on its Web site. The required ratio is the highest in almost a decade.

Seven increases in the reserve requirement and five interest-rate rises this year probably failed to stop the economy expanding faster than 11 percent for a third quarter, a government report may show next week. Surging exports have pumped money into the world's fastest-growing major economy, fanning inflation and fueling a boom in shares and real estate.

``They're clearly concerned primarily about inflation, because it did get out of hand over the summer,'' said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. Inflation ``creates asset bubbles because when inflation is high then it doesn't seem meaningful for people to save money -- they would rather invest in real estate or the stock market.''

China's consumer prices surged 6.5 percent in August from a year earlier, the biggest jump since December 1996. The rate breached the government's annual 3 percent target for a fourth consecutive month, as food costs soared. Inflation was a factor in protests that led to the Tiananmen Square crackdown in 1989.

China's trade surplus jumped 56 percent in September, the customs bureau said yesterday, taking it to $185.65 billion for the first nine months of the year, more than the $177.5 billion for all of last year.

Money Supply

Money supply is surging because the government wants to hold down the yuan, forcing the central bank to sell the currency and pump cash into the banking system. Some of that money is finding its way into stocks, pushing the benchmark CSI 300 Index up 181 percent this year. Money supply rose 18.5 percent in September.

The economy, the world's fourth largest, probably grew 11.5 percent in the third quarter, the government may announce next week, according to the median estimate of 14 economists surveyed by Bloomberg News. The date for the release of the gross domestic product report hasn't been set.

Of 20,000 households surveyed in a central bank quarterly report released Sept. 20, a record 61.3 percent said they expect inflation to quicken in the fourth quarter.

Inflation Expectations

``Inflation is a priority for policy makers because in China, it is not just an economic problem, but also a political risk,'' said Chris Leung, senior economist at DBS Bank Ltd. in Hong Kong. ``The Chinese government wants a `harmonious society,' but how can you have one with prices going up?''

Inflation is raising the risk of social unrest as the ruling Communist Party prepares for its 17th National Congress, a five-yearly meeting starting Oct. 15 that will decide leadership changes.

China has taken other action to combat rising prices.

All government-regulated prices have been frozen until the end of the year, and the state has boosted the supply of grains, vegetables and pigs and cracked down on illegal collusive price increases. The central bank has sold bills to soak up cash from the financial system.

Household Savings

Stock and house prices have gained as households shifted money from low-yielding bank deposits. Household savings fell 41.8 billion yuan in August from the previous month. Housing prices jumped 20.8 percent in Shenzhen and 12.1 percent in Beijing in August.

China has resisted calls from the U.S. and Europe to let its currency strengthen at a faster pace, which would make imports less expensive and ease pressure on domestic prices as well as helping to curb the widening trade surplus.

The yuan has gained about 10 percent to 7.51 versus the dollar since the end of a fixed exchange rate in July 2005.

``Unless the Chinese allow the exchange rate to go up, I'm worried about the stability of the economic system,'' former Federal Reserve Chairman Alan Greenspan said in a speech in London on Oct. 2. ``The exchange rate will create more economic problems than they know.''

The government will be forced into further reserve ratio increases soon, according to Kowalczyk of CFC Seymour Ltd.

``The impact will be negligible,'' he said. ``When you look at how much in yuan terms is taken away from the money market, it's not enough to neutralize the impact of maintaining the exchange rate.''

Last Updated: October 13, 2007 04:56 EDT