China means to counter the Federal Reserve’s monetary easing in the United States

China Move Could Counter Fed’s Efforts

By KEITH BRADSHER

November 19, 2010

HONG KONG — China’s central bank unexpectedly announced on Friday night that it would require commercial banks to set aside a bit more money. It was the second such move by Beijing this month and the clearest sign yet that China means to counter the Federal Reserve’s monetary easing in the United States.

Commercial banks were ordered to transfer an additional 0.5 percent of their assets by Nov. 29 to very low-yielding accounts at the central bank, the People’s Bank of China. The central bank relies mainly on these reserves for the renminbi to buy about $1 billion a day worth of dollars, euros and other currencies — purchases that prevent the renminbi from appreciating.

Beijing, which has largely resisted United States pressure to let the renminbi rise, has argued that the Federal Reserve’s recent easy-money actions are a de facto devaluation of the dollar.

The central bank ordered commercial banks to increase their reserves after many news reports that Ben S. Bernanke, the Federal Reserve chairman, would criticize China on Friday for its currency policies. But the Chinese central bank issued its new regulation before Mr. Bernanke actually spoke, in Frankfurt.

The bank did not mention the Federal Reserve in its one-sentence announcement, which described the move as undertaken “in order to strengthen liquidity management and appropriately control money and credit.”

But economists were quick to point out that the Chinese central bank had chosen a policy stance particularly well suited to holding down the value of the renminbi against the dollar, at a time when the Federal Reserve was trying to increase the supply of dollars by buying longer-denominated Treasuries.

Qu Hongbin, the co-head of Asian economic research at HSBC, wrote in a research note on Friday evening that higher reserve requirements for commercial banks showed that the People’s Bank was “prepared to do whatever it takes to fend off the impact” of the Fed’s monetary easing policies.

Most Western economists, and even some Chinese economists, had been predicting that the Chinese central bank would raise interest rates instead of raising reserve requirements.

Higher interest rates would help cool activity in a Chinese economy that may be overheating. Consumer prices rose 4.4 percent in the 12 months through October, and broadly measured money supply is up 54 percent in the last two years.

Higher interest rates would also reward depositors, many of whom are elderly Chinese. And higher rates would increase costs for borrowers, particularly the state-owned enterprises that account for up to 90 percent of the borrowing in China because of their political clout.

But raising interest rates would also make it even more attractive for international investors to buy renminbi and invest them in China, which would very likely lead to a strong renminbi. The Chinese government is already struggling to continue holding down the value of the renminbi; its relative weakness against the dollar has been crucial to China’s emergence as the world’s largest exporter.

China’s large trade surpluses have created millions of jobs in China, although critics point out that this has been at the expense of employment in its trading partners.

China is also moving rapidly into the manufacture of telecommunications equipment, cars, solar panels and other sophisticated goods in which it competes directly with the United States instead of with emerging economies. That has made it even more important for Chinese companies to have a competitive advantage from a weak currency, and the resulting lower prices of their exports, as they establish footholds in the American market.

To battle inflation, the People’s Bank is already trying to limit incoming investments by people and companies that want to buy Chinese stocks, bonds and real estate. The commerce ministry said this week that it was also tightening scrutiny of incoming investment in new factories and other big projects.

The central bank already requires large commercial banks to park 17.5 percent of their deposits at the central bank. The new order means that requirement will rise to 18 percent on Nov. 29. Two Goldman Sachs economists, Helen Qiao and Yu Song, predicted in a research note that China might raise the reserve requirement again by the end of this year so as to further limit lending and control inflation.

By comparison, the Federal Reserve sets a reserve ratio of 10 percent for all but the smallest banks in the United States, and American banks are not required to hold any reserves against some large categories of deposits.

In China, the renminbi from commercial banks’ compulsory deposits have been the central bank’s main source of money in buying $2.65 trillion worth of foreign reserves. Raising the reserve requirement ratio not only gives the central bank more renminbi with which to buy dollars but also leaves the commercial banks with fewer to lend, which may help cool speculation in real estate and commodities.

The State Council, China’s cabinet, announced late Wednesday that it was drafting price controls for a wide range of foods while seeking to make more food and fuel available. Local authorities were also ordered to provide subsidies for the needy.