China may raise bank reserves to curb liquidity

BEIJING, Mar 29 (Reuters) China may raise bank reserve requirements for the first time since April 2004 to tackle abundant liquidity at banks and rein in money supply, a government economist was quoted on Wednesday as saying.

Speculation that the People's Bank of China might raise reserve requirements has gained momentum since vice central bank chief Wu Xiaoling told a forum on March 18 that monetary policy must aim to reduce excessive liquidity.

Wu said then the central bank could find it harder to conduct open market operations because banks would be more eager to lend to companies rather than buying the central bank's paper.

''Raising reserve requirements will be a difficult choice for the central bank,'' the Xinhua news agency quoted Liu Yuhui at the Chinese Academy of Social Sciences, a top government think-tank, as saying.

''But the central bank it will have to make a choice, even though it's difficult,'' Liu was quoted as saying. ''The central bank may eventually have to raise reserve requirement to reduce money supply.'' The central bank last raise bank reserve requirement on April 25, 2004, for the third time in less than seven months, seeking to cool rapid credit growth and rein in overheating investment.

Since that half-percentage-point rise, big commercial banks have had to put 7.5 per cent of their deposits at the central bank. Smaller banks must deposit 8 per cent.

The central bank uses its open market operations to mop up some of the yuan it releases through buying of dollars to hold the yuan exchange rate down -- the fundamental source of excess liquidity in the banking system.

Zhu Jianfang, economist at China Securities said he expected a rise in reserve requirements as early as in April, after the government issued first-quarter economic indicators, and the size of the rise could be higher than 0.5 percentage point.

''Currently, growth of credit and investment are strong, the amount of yuan liquidity associated to foreign exchange inflows hasn't slowed and more central bank bills are maturing,'' he said.

But Song Guoqing, chief economist at China Stock Exchange Executive Council, a think-tank in Beijing, said he believed any rise in reserves would not resolve the problem of excess liquidity, because some banks already deposit more with the central bank than they have to -- so-called excess reserves.

Zhu said the central bank may reduce the interest rate on excess reserves for banks. The interest rate is now 0.99 per cent.

Most economists say the central bank is unlikely to raise bank interests rates this year, because inflation would stay benign.

The central bank sharply cut the volume of its open market operations on Tuesday, but yields on its bills still hit a near 10-month high after its efforts to curb money supply growth hit market liquidity.

The central bank mopped up 40 billion yuan ( billion) from the banking system on Tuesday, about a third of the 115 billion yuan absorbed a week ago.

But yields on the central bank's benchmark one-year bills rose to 2.0144 per cent on Wednesday from 1.9888 percent on Tuesday, extending rises of recent days.

China's M2, a measure of how much liquidity is available in the banking system, was 18.8 per cent higher at the end of February than a year earlier, growing much faster than Beijing's planned 16 per cent for 2006.

REUTERS SD SND1526