China's central bank sprung a surprise yesterday when it asked commercial banks to set aside more money as reserves to curb excess liquidity.
It will be the fifth increase announced in the past eight months.

The reserve ratio - the amount of money a bank must hold at the central bank - will increase 0.5 percentage points to 10 percent on yuan deposits starting on February 25, the People's Bank of China said on its Website yesterday.

"China is still facing excess liquidity amid its international payment surplus, though previous measures to curb liquidity have borne some fruits," it said. The central bank wants to both trim liquidity and maintain the momentum of its previous increases.

"The hike has delivered a strong tightening signal right before the Chinese New Year," said Liang Hong, a Goldman Sachs economist. "This surprise move by the PBOC could have been triggered by the strong credit growth in January."

China's M2, the broadest measure of money supply which includes cash and all deposits, grew 15.9 percent in January, against a 16.9 percent in December.

Despite the M2 growth dip, M1, or cash plus current accounts, rose 20.1 percent year on year, the fastest in some 3 1/2 years. It triggers concerns that bank lending is off to a strong start again.

"Chinese New Year usually involves everyone giving out cash bonuses," said Stephen Green, a Standard Chartered Bank senior economist. "Today, the PBOC decided to reverse tradition with the hike."

Green expects a 50-basis-point increase on the reserve once a quarter this year as an effective and cheap tool to cut liquidity in the banking system.

"In hindsight, one can view this as the PBOC preparing for the post-Chinese New Year effect, whereby funds come back into the banking system after exiting it pre-holiday," he said.

"Move now and you can lock some of those funds up as soon as they hit the system in the week beginning on February 26."

For instance, capital worth 120 billion U.S. dollars locked up in application accounts for Ping An Insurance's initial public offering was released yesterday.

Economists believe the latest ratio increase will have a limited effect.

"In the short run, the reserve requirement hike will likely push up market interest rates and the yield curve modestly in China," said Liang. "However, we do not expect this tightening measure to have much impact on the real economy or the financial markets."