China takes new step to rein in lending, inflation

CHRISTOPHER S. RUGABER - AP Business Writers,JOE McDONALD - AP Business Writers
November 19, 2010
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In this file photo taken on Nov. 17, 2009, a bank clerk stacks up renminbi banknotes at a bank in Hefei in central China's Anhui province. China has ordered its banks to hold back more money as reserves in a new move to curb lending and cool inflation. The order Friday Nov. 19, 2010, was China's second reserve increase in two weeks and came as Beijing tries to restore normal financial conditions and curb inflation after its recovery from the global crisis. (AP Photo) ** CHINA OUT **

China ordered its banks Friday to hold more money as reserves in a new move to curb lending and rising inflation that communist leaders worry might stir unrest.

It was China's second reserve increase in two weeks and came as Beijing tries to restore normal financial conditions following its recovery from the global crisis and cool inflation that surged to a 25-month high in October.

The move comes amid heightened tensions between the United States and China over the nations' currency and economic policies. Critics charge that China could cool its economy and tame inflation by letting its currency, the yuan, float freely against the dollar.

China has steadfastly refused, keeping the yuan closely tied to the dollar. That makes its exports cheaper overseas and U.S. products less competitive in China. U.S. manufacturers and members of Congress charge that gives China an unfair advantage.

Federal Reserve Chairman Ben Bernanke added his voice to the critics on Friday. China's policy of keeping the yuan artificially cheap is distorting the global economy, he said.

China is not likely to change its currency policy under pressure from the U.S. But it is taking steps to cool its economy. Analysts expect China to announce an interest rate hike before the end of the year, its second after a surprise increase Oct. 19, but there was no word Friday of any changes in rates.

The state-owned banking industry was ordered to set aside an additional 0.5 percent of deposits as reserves, effective Nov. 29. Reserves vary by institution but could be as high as 19 percent for the biggest commercial lenders.

Economists say money flooding through the economy from China's stimulus spending and heavy bank lending helped to push inflation to 4.4 percent in October, well above the government's 3 percent target. Politically sensitive food costs jumped more than 10 percent.

Poor families in China spend up to half their incomes on food and communist leaders see inflation as a possible trigger of unrest.

Regulators worry that excessive lending is fueling overspending on real estate and other assets and might leave banks burdened with unpaid loans if ill-considered projects default.

China is taking steps to cool its economy and fight inflation at the same time the Federal Reserve is trying to boost economic growth and ward off the threat of deflation, a destabilizing drop in prices and wages. The Fed launched a $600 billion bond-purchase program earlier this month, hoping to lower interest rates and spur more borrowing and spending.

"The differences between the two countries couldn't be more extreme," said Julia Coronado, chief economist at BNP Paribas.

Those differences have contributed to rising international tensions over economic policy. China and some other countries have charged that the Fed's plan will weaken the dollar and give U.S. exporters a price advantage in overseas markets. A weaker dollar makes U.S. exports cheaper.

Bernanke shot back at his critics Friday. He said that if China allowed its currency to appreciate, its economy would cool, lowering inflation. Meanwhile, manufacturers in advanced economies such as the United States would benefit as China's exports became more expensive.

"The net result would be more balanced and sustainable global growth," Bernanke said.

The Fed chairman's comments come just days after a U.S. congressional report called on Washington to do more to force China to increase the value of its currency.

On Friday, the Chinese Foreign Ministry countered such action would constitute interference in Beijing's internal affairs and accused the U.S.-China Economic and Security Review Commission of having a "Cold War mentality."

Friday's order came after China's stock markets closed. Stocks fell this week on investor fears the government might respond to October's inflation by tightening economic controls and further slowing China's growth.

China's post-crisis expansion peaked at 11.9 percent in the first quarter of this year and cooled to 9.6 percent in the three months ending in September. The World Bank says next year's economic growth should slow to 8.7 percent.

Raising reserve requirements allows Beijing to slow lending growth without increasing costs for borrowers through a rate hike. The government has used such targeted tools to try to restrain housing costs and make other changes while avoiding large rate increases.

A rate hike is politically fraught because it increases costs for state companies and heavily indebted finance agencies set up by local governments to use bank loans to invest in infrastructure and real estate projects.

Analysts say the modest quarter percentage point rate hike on Oct. 19 was meant as a warning to banks to cut back runaway lending.

Chinese leaders also worry that higher interest rates will attract inflows of foreign speculative "hot money" into stocks and real estate. Unauthorized inflows of money meant to profit from China's rebound and a rise in its currency, the yuan, have surged in recent months despite Beijing's moves to tighten capital controls.

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Rugaber contributed to this report from Washington.