The Shanghai composite index slides 1.2% on news that the central bank will – again — hike the amount of capital banks are required to hold in reserve.

Reporting from Beijing
China’s leading stock exchange continued its long slide Tuesday, tumbling to its lowest close in seven months after the central government introduced another measure over the weekend to try to cool the nation’s soaring economy.

The Shanghai composite index, which was closed Monday for Labor Day, fell 1.2% in response to a central-bank announcement Sunday that it would hike for the third time this year the amount of capital banks must hold in reserve.

The move signaled another attempt by policymakers to mop up excess liquidity blamed for fueling a property bubble and raising the specter of bad loans and high inflation.
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China’s economic output grew by 11.9% in the first quarter, stoking fears the economy was overheating.

The People’s Bank of China – the central bank – will raise the reserve-requirement ratio for major banks by half a percentage point. The directive, which takes effect Monday, means institutions will have to store 17% of their deposits as reserves. It’s estimated the hike will drain about $44 billion from the banking system.

Holding more reserves is supposed to make it harder for banks to over-lend. Beijing approved a record $1.4 billion in new loans last year and had set a target of $1.1 billion this year. After the first quarter, however, some banks were on pace to overshoot that target and had earned record profits in doing so.

On Tuesday, however, bank and property shares led losses on the Shanghai stock exchange, which fell 1.2% to finish trading at 2835.3 points. The bourse is already down 13% this year, making it one of the worst-performing stock indices in the world over that period.

Investors were especially rattled last month when the central government unveiled new rules to crack down on property speculation such as increasing down payments on second homes and giving banks new powers to deny loans.

“Investors can feel the government tightening policies,” said Chen Wenzhao, an analyst at China Merchant Securities. “In the short term, it will be hard for the stock market to rebound. You have to wait and see the impact of the new measures. In China, government policy always leads the market.”

Some analysts believe the new reserve requirements will do little to tame inflation and believe a more heavy-handed approach of increasing benchmark interest rates may soon be necessary to prevent money sloshing around.

That’s because investors have few alternatives in a country with a paltry consumer savings rate. Chinese banks offer depositors a 12-month interest rate of 2.25% — 0.15% less than the rate of inflation in March. That has ignited a rush to borrow money and invest in residential property instead.

Pressuring banks and hiking reserve ratios “alone will become obviously inadequate very soon,” said Jun Ma, chief China economist for Deutsche Bank. “These policy tools are helpful in controlling liquidity and loan growth but are not immediately effective in dealing with negative real interest rates, inflation expectations and spot prices. Within a few months, the government will have very few choices but to resort to rate hikes and some price controls.”

By David Pierson

Tags: banks, central bank, China, economic recovery, economy, financial, Global Economy, interest rates, investors, money, stock market

This entry was posted on Tuesday, May 4th, 2010 at 11:10 am and is filed under Chinese Finance, Economic Turmoil, Global Economy, Global Financial, Market Finance, World Financial. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.