Related story: China to raise commercial banks' reserve ratios

    BEIJING, June 19 -- The central bank's decision last Friday to raise reserve requirements for commercial banks was meant to drive home the monetary authorities' resolution to rein in excessive lending and fixed-asset investment.

    By increasing the reserve ratio 0.5 percentage points to 8 per cent starting on July 5, the People's Bank of China will squeeze 150 billion yuan (US$18.7 billion) of liquidity from the banking sector.

    Though a small sum compared with the surge in bank loans, this reduction of money supply might signal the beginning of the end of easy credit.

    New loans granted by domestic banks reached 2.12 trillion yuan (US$264 billion) in the first five months of this year, accounting for about 85 per cent of the central bank's annual target. Meanwhile, urban investment in factories, infrastructure and real estate jumped 30 per cent year-on-year.

    The monetary authorities certainly cannot afford to allow banks to continue lending at such a pace.

    As the central bank correctly pointed out in an earlier report, the rapid expansion of credit, along with increased fixed-asset investment, is largely a result of domestic banks' desire to make greater profits and local governments' relentless pursuit of investment-led economic growth.

    Since lending is domestic banks' major source of profits, they have ample reasons to grant as many loans as possible. This may particularly be the case in a period when newly listed domestic banks are eager to woo investors from home and abroad. And when the cost of money remains very low, local governments and enterprises naturally have a strong incentive to borrow and invest more.

    If the spiral of credit growth and investment expansion cannot be checked in a timely fashion, the country's efforts to cool economic growth and its long-term attempts to shift from extensive growth to balanced and sustainable growth will be seriously undermined.

    In April, the central bank raised its benchmark lending rate for the first time in two years to tighten credit. But the persistent surge in bank loans and investment in May requires more tightening measures to take place.

    Higher interest rates are usually thought to be the most effective way to adjust money supply. Yet, it is obvious why the central bank has decided against this course of action.

    Domestically, in spite of its growth momentum in recent months, the consumer price index, the main gauge of inflation, remained as low as 1.4 per cent in May. The monetary authorities need more time to understand and respond to inflationary pressures.

    Internationally, an interest rate rise will more than likely add to the appreciation pressure on the renminbi by inviting more capital inflows. China's record trade surplus achieved in May has already given rise to such revaluation calls.

    Under such circumstances, the central bank's move to raise the reserve ratio should be interpreted as a display of the monetary authorities' firm resolution to slow credit growth and thus cool investment expansion.

    All commercial banks and local governments and investors should take this message to heart.

    (Source: China Daily)