CURB EXCESS MONEY: China is withdrawing money from circulation to tame inflation (MENG ZHONGDE)

While the U.S. Federal Reserve announced a second round of quantitative easing (QE2) on November 3, China's central bank is tightening its money supply.

The People's Bank of China raised the reserve requirement ratio for all financial institutions by 0.5 percentage points on November 16, the fourth time this year the ratio has been raised.

This is the second action taken by the central bank within a month. On October 20, it raised the benchmark one-year lending and deposit rates by 0.25 percentage points, marking the first rate increase in 33 months.

The central bank's quarterly report of monetary policy released on November 2 said that it would continue its moderately loose monetary policy and make it more flexible. But it also mentioned that the central bank would gradually normalize the monetary policy from its counter-crisis model and tighten control over liquidity to maintain moderate credit growth.

The claim of gradually guiding monetary conditions back to their normal state—which refers to pre-crisis levels—may usher in a period of tightened control, said an analysis report from the Beijing-based Essence Securities.

Monetary oversupply

China adopted a prudent monetary policy before 2007. The central economic working conference at the end of 2007 decided to tighten the money supply for the following year to prevent inflation. The policy had only been in place for a few months and in September 2008 China began adopting a relatively loose monetary policy to fight the global financial crisis.

This year, China's gradual shift in its monetary stance was caused by serious monetary oversupply. According to data released by the National Bureau of Statistics and the People's Bank of China, while China's GDP increased 92 times compared to 1978 figures, its broad money supply, which covers cash in circulation and all deposits, increased 705 times in the same period.

What's more, China's broad money supply reached 69.64 trillion yuan ($10.45 trillion) by the end of September, nearly 43 trillion yuan ($6.46 trillion) higher than the country's GDP of 26.87 trillion yuan ($4.03 trillion) in the first three quarters this year.

China's economy now faces asset bubble risks due to the large scale of liquidity, said Li Daokui, a member of the Monetary Policy Committee of the People's Bank of China and an economics professor at Tsinghua University.

Li said that China's money stock, exceeding $10 trillion, is now the world's highest and its ratio to GDP is about 200 percent. This will inevitably bring about systemic financial risks.

Averting risks

Many Chinese economists agree getting the monetary policy back to normal will be a choice move by the central bank given the circumstances.

Differing from developed countries, emerging economies that have maintained loose monetary policies have also gradually tightened their money supply. This is more than reasonable, considering the problems they're facing, said Hou Yunchun, Deputy Director of the Development Research Center of the State Council.

Hou said that developed countries still suffered from high unemployment, high debt ratio and low economic growth this year. As a result, Japan and the United States chose to proceed with easy fiscal and monetary policies to stimulate their economies. European countries tightened their fiscal policies while relaxing their monetary policies. Fast-growing emerging countries are fighting against overheated economies, inflation and asset bubbles. Therefore, some, including China, had to adopt the "loose fiscal and tight monetary" model.

Wu Xiaoling, Vice Chairwoman of the Financial and Economic Committee of the National People's Congress, said if the Chinese Government slows its annual GDP growth rate to 7.5 percent or 8 percent and controls its CPI growth within 4 percent (instead of the previous goal of 3 percent) over the next five years, the growth rate of the broad money supply should be controlled at 13-14 percent to avoid too much liquidity.

Wu also warned that although a tight monetary policy may help fight against inflation and asset bubbles, it will inevitably impair economic growth to some extent. It's still uncertain whether the Chinese economy can endure this side effect, Wu added.