China raises bank reserves to 21% in (so far unsuccessful) fight against inflation

05/12/2011 1:05 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Another month, another increase in the reserve requirement for China’s banks.

Today, May 12, the People’s Bank raised the reserve requirement by another 0.5 percentage points to a record 21%. This is the fifth times this year and the eighth time since October that China’s central bank has raised the percentage of assets that a bank needs to keep in reserves. (Money in reserves is money that can’t be lent out. In theory raising the reserve requirement should slow the economy and help control inflation.)

Unless my math is off, that’s one increase a month since October 2010.

You might think the move would be old hat by now, but it’s not. In fact today’s move has raised new worries in China’s financial markets.

What worries?

First, those analysts and economists who expected that the next move by the People’s Bank would be an increase in benchmark interest rates worry that today’s move signals belief at the People’s Bank that China’s economy might be slowing too much even as inflation continues well north of the government’s 4% target. (Inflation for April came in at a 5.3% annual rate.) That worry started yesterday with the release of a growth rate for factory output that was slightly below expectations.

Second, now that the reserve requirement has broken above the previous top and entered new territory, no one is quite sure where the People’s Bank might stop. I’m seeing worried speculation that says a 23% reserve ratio isn’t out of question.

Third, the increases in reserve requirements have been so regular and the effect on inflation so hard to see that some economists have begun to ask if raising the reserve requirement at this rate is just keeping up with the flow of hot money into the country. Pulling $100 billion out of circulation with each hike in the ratio isn’t enough to do much more than balance cash flows into China. Raising the reserve requirement at this pace, they worry, won’t do anything to slow inflation.

And fourth, if increases in reserve requirements are ineffective at fighting inflation, then maybe, this worry goes, the consensus that the People’s Bank will need to raise benchmark interest rates just once or twice more before inflation peaks is wrong. I sense a shift from a belief that one or two more increases is the most that the market can expect toward a view that one or two increases is the least that the People’s Bank might impose.

 

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