China’s Reserve-Ratio Rise May Not Be Enough to Whip Inflation

May 3 (Bloomberg) -- China’s third increase of bank reserve ratios this year left benchmark interest rates and the yuan’s peg to the dollar unchanged, risking the need for more concerted effort to contain property prices and inflation in coming months.

The requirement will increase 50 basis points effective May 10, the People’s Bank of China said on its Web site yesterday. The current level is 16.5 percent for the biggest banks and 14.5 percent for smaller ones.

The latest move adds to a government crackdown on property speculation after record price increases in March and came on a holiday weekend, with Chinese markets shut today. Within an hour of the central bank announcement, Finance Minister Xie Xuren said that officials remained committed to expansionary policies to cement the nation’s recovery.

“Beijing still prefers to fine-tune credit conditions and the property market rather than using blunter instruments that impact the entire economy like higher lending rates and a stronger currency,” said Brian Jackson, a Hong Kong-based strategist at Royal Bank of Canada. The danger is that the approach “will not be enough to keep these price pressures under control, which would then force policy-makers to tighten more aggressively later on.”

Yesterday’s move removes 300 billion yuan ($44 billion) from the financial system and may push back an interest-rate increase until “early June,” according to Deutsche Bank AG.

The Shanghai Composite Index has tumbled 12 percent this year on concern that government measures to cool the property market and the economy will hurt profits.

Speculative Capital

Inflows of speculative capital from investors betting on yuan gains may have driven yesterday’s move, said Lu Zhengwei, a Shanghai-based economist at Industrial Bank Co.

Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong, said “China has been inundated with hot money on the back of yuan revaluation speculation.”

Non-deliverable yuan forwards indicate the government will end the peg to the dollar, letting the currency gain 3.2 percent within 12 months.

In March, a $22.5 billion jump in foreign-exchange reserves, the biggest gain in four months, suggested investors could be showing a renewed appetite for bets on the currency. Exports and company profits are rebounding and the economy expanded 11.9 percent in the first quarter from a year earlier.

Surging Profits

Baoshan Iron & Steel Co., the nation’s largest publicly traded steelmaker, estimates first-half profit may increase as much as 10-fold, while Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. posted the largest first- quarter profits among the world’s banks.

Still, Chinese policy makers have expressed caution about the outlook for the domestic and global economies as Europe, the nation’s biggest export market, grapples with a debt crisis. The emergency in Greece makes an interest-rate increase “less and less likely” this quarter and could delay gains in the yuan, Bank of America-Merrill Lynch said last week.

“The foundation of the recovery in the Chinese economy is not very solid, so we will continue to adopt a moderately loose monetary policy and an expansionary fiscal policy,” Xie, the finance minister, said in Tashkent, Uzbekistan, yesterday.

Speculation that China was poised to let the yuan gain intensified last month after U.S. Treasury Secretary Timothy F. Geithner delayed a report that could name the nation a currency manipulator and had an unscheduled meeting in Beijing with Chinese Vice Premier Wang Qishan. The currency trades at about 6.83 per dollar.

Central Bank’s Trigger

Manufacturing accelerated in April and material costs jumped, a May 1 report showed, underscoring the risk of overheating in the fastest-growing major economy. Those data, and possibly strong loan growth in April, may have triggered yesterday’s move, said Liu Li-Gang, a Hong Kong-based economist at Australia and New Zealand Banking Group Ltd.

Reserve-ratio increases and the targeting of a 22 percent reduction in new loans this year are among efforts to wind back stimulus that has driven the nation’s recovery from the financial crisis. Measures to cool the real-estate market have included a ban on loans for third-home purchases and raising mortgage rates and down-payment requirements for second-home purchases.

In March, property prices rose 11.7 percent across 70 cities from a year earlier, the most since data began in 2005. The inflation rate was 2.4 percent, compared with a government target for the year of about 3 percent.

Inflation Eroding Savings

In February, consumer prices rose 2.7 percent, the most in 16 months, topping the one-year deposit rate of 2.25 percent. The benchmark one-year lending rate is 5.31 percent.

PBOC Deputy Governor Zhu Min said March 25 that rate rises were a “heavy-duty weapon” and alternative measures were working well.

China faces a complex economic environment this year amid a weak global recovery and domestic challenges including managing inflation expectations and risks from local-government borrowing and property loans, banking regulator Liu Mingkang said April 30.

Investor Marc Faber said April 21 that China’s “excessive” credit expansion and surging real-estate prices are “danger signals” and “there are some symptoms of a bubble building.”

China appears heading for an “asset boom, bubble and bust” that probably won’t be thwarted by tighter economic policy, Citigroup Inc. economists said in a March report. It may take as long as two years for the bubble to form and at least three years for it to burst, London-based Willem Buiter, a former Bank of England policy maker, and Shen Minggao in Hong Kong estimated.

Premier Wen Jiabao’s government is aiming to slow credit growth to 7.5 trillion yuan ($1.4 trillion) this year from a record 9.59 trillion yuan in 2009. In the first three months of 2010, banks lent 35 percent of the full-year target.

--Kevin Hamlin, Li Yanping, Sophie Leung, Feiwen Rong, Shamim Adam. Editors: Chris Anstey, Paul Panckhurst.