Liquidity looms behind excess deposit reserve ratio

    By Ding Qi (chinadaily.com.cn)
    Updated: 2007-08-10 17:17

    By the end of June, the ratio of excess deposit reserves, or money from commercial banks parked at the central bank above requirements, grew much higher than expected, indicating a setback in the financial authorities' tightening measures against excess liquidity, according to the China Securities Journal.

    Why did the usually powerful monetary fists of the central bank fail this time? A probe into the financial mechanism as well as the market may lead to better understanding.

    Assuming the monetary needs of commercial banks remain steady, the excess deposit reserve will go down with the hike in the required reserve ratio, since the extra money was transformed into the required reserves.

    It had been widely expected that the excess deposit reserves would fall to 2 percent in June since the central bank raised the reserve ratio three times between April and June this year. But the figure released in the central bank's second quarter monetary report surprised most people -- 3 percent! -- only 0.08 percentages lower than a year earlier and even higher than in the first quarter.

    Liquidity from the trade surplus and ineffective open market operation are behind the surging figure.

    In June, the country's trade surplus reached 203 billion yuan (US$26.9 billion), 90 billion yuan higher from a year earlier, adding heaps of cash to the domestic market.

    In addition, open market operations, generally considered an important tool of the central bank in dealing with excess liquidity, didn't work because of poor central bank note sales.

    Because of a wide inflation expectation after the release of a soaring Consumer Price Index (CPI) in May, the yield of bonds grew greatly in June, making the market reluctant to accept notes with lower yields from the central bank. On the other hand, in order to prevent an influx of hot money, the central bank refused to raise bank note yields, impacting sales.

    As a result, nearly 30 billion yuan flooded the market in June. In comparison, during the same month last year, the central bank successfully withdrew 95 billion yuan through open market operations. The difference is 125 billion yuan.

    Since two major monetary tools against liquidity – reserve ratio hike and open market operations, didn't bear fruit in dealing with excessive liquidity so far. The central bank was forced to seek other ways, according to the reports.

    For the first time, the central bank noted in its quarterly monetary report that it would seek new measures as well as conventional ones to bring excess liquidity under control. One of the new measures, according to some analysts, may refer to the 1.55 –trillion-yuan special bonds, which is thought to be issued soon.

    In addition, the central bank has taken actions against excessive loans from commercial banks by providing some policy guidance. Many commercial banks were told to reduce their overall credit scale and apply strict controls on second-hand property loans, or even credit for new houses.


    (For more biz stories, please visit Industry Updates)



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