China Raises Key Banking Standard

China raised a key banking benchmark over the weekend in a further attempt at preventing the nation's economy from overheating.

China's central bank lifted the reserve ratio requirement on Saturday by a full percentage point to 14.5%. This is the tenth increase this year in the ratio, which measures the percentage of money banks are required to hold against deposits, and it comes just days after the central bank shifted to a "tightening" monetary policy from a "stable" one.

Beijing last lifted the ratio by half a point on Nov. 10. Such increases are significant, and not only for their immediate impact on lending, because they are generally seen as an indication of a pending interest rate hike.

China watchers will get more economic data to chew over in the coming week, when Beijing releases new statistics.

"This is just a follow-up policy decision on Beijing's aim to cool inflation and excess liquidity," says Zuo Xiaolei, chief economist of Galaxy Securities. "From an economic point of view it is neither a good nor a bad thing, it's just a case of 'it will have to do,' given China's excess liquidity problem."

China's reserve ratio requirement is now at its highest level since it was introduced in 1984. Even so, this year's increases in the ratio have failed to stem inflation, which has risen to a 4.5% rate, spurred mostly by an increase in the cost of food and consumer products. The November increase did appear, however, to add to downward pressure on Chinese stocks. Since Nov. 10, the Shangai Composite index has lost 4.5%.

A higher reserve ratio requirement also may be helping to improve loan performance. On Nov. 8, a central bank official in Beijing told local journalists that recent data showed that loan performance has improved by by 27.7 percentage points since December 2002, as a result of improved monetary policy and regulation.

The latest increase in the requirement is double the usual half-point increase, and significantly, comes ahead of an expected interest rate cut in the U.S. this week. The differing stances on monetary policy in the U.S. and China contribute to what some market participants see as a further "decoupling" of the traditional economic relationship between the world's largest economy and the world's fastest growing one.

Galaxy's Zuo says that in addition to China, Thailand, India and Hong Kong are all experiencing an excess liquidity supply right now, too.

"Capital inflow to the emerging markets, and to China in particular, is increasing rapidly because of the problems in Wall Street, as foreign investors are increasing their allocations here," says Zuo. "Emerging markets are generally not very mature or large-scale, so these inflows could be a problem that will cause a bubble in asset prices."