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The People's Bank of China, the country's central bank, said it will raise the legal reserve ratio on bank deposits by 0.5 of a percentage point for the fourth time in seven months to prevent a rebound in lending and investment.

The move will take effect from January 15, according to a statement from the People's Bank of China published on its website on Friday. Banks will have to set aside 9.5 percent of their deposits as reserve, cutting capital for lending.

The central bank said the increase is due to the continued growth of the trade surplus, which has led to excessive liquidity in the banking system.

Despite its effective macroeconomic regulation in 2006, the central bank said: "There is a new increase in excessive liquidity in the banking system as a result of the continuing trade surplus, which adds to pressure for expanded lending."

Analysts said the hike is predictable given China's ballooning trade surplus, which may soar to 168 billion yuan (US$21.5 billion) in 2006, according to various forecasts.

"The huge surplus will increase foreign exchange reserves and, accordingly, lead to an increase in renminbi liquidity," said Professor Li Yongsen from the Financial and Securities Institute at Renmin University of China.

Analysts said recent statistics indicated that investment may rebound, which may have worried the central bank.

In November, the money supply indicator M1, which largely reflects the scale of money in the hands of enterprises, increased 16.8 percent year-on-year. And the profits of industrial enterprises surged by 35.7 percent year-on-year.

"They are combined to indicate that enterprises have ample capital, which may lead to a surge in investment," said Xue Hua, an analyst at the Shenzhen-based China Merchants Securities.

Compared with a hike in the interest rate, raising the bank deposit reserve ratio is a better choice for China, Li said.

"Raising the interest rate of renminbi deposits and lending would, according to international experience, push up the exchange rate of the renminbi in the short term," he said.

Li said the latest hike, together with three previous adjustments last year, are all small size adjustments that demonstrate the regulators' expertise in using financial tools. "They reflect the consistent stance of the policymakers, who want to maintain economic stability while reducing excessive liquidity."

(China Daily January 6, 2007)