China's reserve ratio rises again - interest rates next?

China appears to be set on controlling a potentially overheating economy by restricting the ability of China's commercial banks to lend money. This will have the affect of absorbing liquidity and lowering bank lending (especially for smaller banks).

However, such liquidity tightening methods are rarely used by Western governments as banks have endless methods of getting around such restrictions.

Moreover, such a small increase (even if it is the seventh in a row could be seen as minor tinkering given China's rapid growth (over 11%) and inflation creeping up to 3.3%.

Interest rates will have to rise and the currency appreciate. As we have said before on this blog however, is that domestic consumption needs to increase and savings need to fall - for this to happen requires huge structural and cultural changes with precautionary savings only falling as the social security net widens (which all costs money and requires investment).

The China Daily article gives a decent if badly written overview. Some quotes are included in this post.

China hikes bank reserve ratio to cool investment

The deposit reserve ratio for depository financial institutions will be raised by 0.5 percentage point to 11 percent starting on May 15, the People's Bank of China said in a statement on its website.

That marked the seventh hike in less than a year in addition to three interest rate increases as regulators try to prevent the economy from overheating.

China's economy surged 11.1 percent in the first quarter of this year after growing 10.7 percent in 2006, as shown in official statistics.

Meanwhile, fixed-asset investment countrywide grew a robust 23.7 percent during March, while the consumer price index (CPI), a key indicator of inflation, rose 3.3 percent last month, above the government's three percent target.

In the first quarter, China's commercial banks posted a 16.25 percent growth in loans, up 1.52 percent from the same period last year.

Meanwhile, Zhu noted the reserve ratio hike is a mild control mechanism, compared with an interest rate increase, especially during the current sensitive period leading to the May Day holiday. There has been speculation in the market that the central bank may raise the interest rate before, during or soon after the holiday.

This final quote is telling - expect a rate rise AFTER the May day holiday but not before.

The asset bubbles in China are growing....