China's central bank Sunday raised the amount of money banks must set aside in reserves, reducing the money available for lending, in the latest move to rein in the investment boom.

The deposit reserve ratio for depository financial institutions will be raised by 0.5 percentage point to 11 percent starting on May 15, the People's Bank of China said in a statement on its website.

"The increase is aimed at stepping up liquidity management of the banking system and to guide a reasonable growth of credit," said the statement.

That marked the seventh hike in less than a year in addition to three interest rate increases as regulators try to prevent the economy from overheating.

China's economy surged 11.1 percent in the first quarter of this year after growing 10.7 percent in 2006, as shown in official statistics.

Meanwhile, fixed-asset investment countrywide grew a robust 23.7 percent during March, while the consumer price index (CPI), a key indicator of inflation, rose 3.3 percent last month, above the government's three percent target.

In the first quarter, China's commercial banks posted a 16.25 percent growth in loans, up 1.52 percent from the same period last year.

Reserve ratio might be raised to 15 percent

The latest move by the central bank indicates it is more concerned about excessive liquidity than inflation, said Shen Minggao, an economist with Citigroup in Beijing.

Zhong Wei, a professor with Beijing Normal University comments that raising the reserve ratio is the best choice for absorbing liquidity and controlling the banks' credit scale.

"The ratio might be raised to 15 percent at the year end," he predicted. But this policy can't sustain, as it will hurt the long-term operation of commercial banks, Zhong added.

As for the short-term influence on banks, Cheng Qingwei of China Citic Securities said the small banks will be more affected than larger ones.

Pressure for interest rate rise remains

Shen of Citigroup expected a higher possibility of an interest rate increase in the second quarter.

"Actually, inflation is not a big problem," explained Shen, adding the motive for an interest rate hike lies in the fact that the real interest rate is negative, promoting the flow of capital into the equity market and leading to asset bubbles.

China's benchmark one-year deposit rate now stands at 2.79 percent and interest income in the country is subject to a 20 percent tax. The inflation hit 3.3 in March.

However, Gao Shanwen, chief economist with Anxin Securities opposed to an interest rate hike.

"The data on CPI, PPI (producer price index) and investment are all within the acceptable range," said Gao, adding the CPI growth fueled by the food price increase is only a transitional phenomenon.

He expected inflation to continue to rise in the second quarter, and then start to fall from July onwards.

However, he admitted the pressure for an interest rate hike at the end of June still exist as the time lag effect in previous policies would keep the investment figure in the second quarter at a high level.

Influence on stock market is limited

"But any hike will have limited influence on the asset prices and the flow of bank deposits into the equity market will continue," said Gao.

He Qiang from the Central University of Finance and Economics and Zhu Jianfen, former chief macro economist of China Securities Co., Ltd shared Gao's opinion.

He expects the market to open lower before rising again on Monday. However, he warned of a correction when the market which has grown 40 percent so far this year, continue to climb. And he suggested investors should find the right time to lock in profit and exit the market.

Meanwhile, Zhu noted the reserve ratio hike is a mild control mechanism, compared with an interest rate increase, especially during the current sensitive period leading to the May Day holiday. There has been speculation in the market that the central bank may raise the interest rate before, during or soon after the holiday.

The influence of the new policy on the stock market is limited and the negative effect could be neglected, added Zhu.

Editor: Donald