A few days after the eighth hike of reserve requirement ratio this year, the People's Bank of China was reported to be planning to restart use of the special deposit.

The move aims to absorb funds from financial institutions, which are not primary dealers of open market business, as a special deposit at the central bank.

By making more financial institutions subject of the central bank's efforts to rein in liquidity growth, the reuse of a monetary tool that has not been tried for two decades highlights not only the urgency to soak up excess liquidity in the banking system but also policymakers' resolution to do it.

Because of robust growth of the trade surplus and inflow of foreign direct investment, China's foreign exchange reserves have kept swelling to pump more and more liquidity into the domestic market.

China's trade surplus hit $185.6 billion in the first nine months, surpassing the full-year figure in 2006. Meanwhile, the amount of foreign direct investment China actually attracted reached $47.2 billion, up 11 percent year on year. They have together driven the country's foreign exchange reserves to $1.43 trillion.

Consequently, the country's annual growth in broad measures of money supply accelerated to 18.5 percent in September, 0.4 percentage points higher than August.

In face of such accelerated monetary supply and excess liquidity that floods the domestic market, the monetary authorities are obliged to take more tightening measures.

Eight increases in the reserve requirement ratio for commercial lenders so far this year have taken away most of the extra liquidity from the market while bringing the ratio on par with the historical high. The central bank can certainly further hike the reserve requirement ratio to rein in the growth of liquidity. But there is a limit to the amount that commercial lenders must hold in reserve if their profitability will not be seriously affected.

Hence, the re-introduction of the special deposit that allows the central bank to withdraw liquidity from a wider range of financial institutions before they become more than needed.

It will help cement policymakers' efforts to effectively curb liquidity growth. More importantly, it signals both increased concern about excess liquidity and the firm determination to prevent it from fueling inflation in the country.

(China Daily 10/18/2007 page9)