Russia ................. Ho ang hon email@example.com 852-2978-1941 China Views July 21,2006 GSGLOBALECONOMICWEBSITE Economic Research from the GSInstitutional Portal at 1 ng Li g.l The People’s Bank of China Raised Reserve Requirement Ratio by 50 Basis Points Again The People’s Bank of China (PBOC) raised the reserve requirement ratio (RRR) today by 50 basis points again to 8.5% from 8.0%, effective from 15 August,2006. This is a surprise move, given that the RRR was hiked 50 bps just a month ago. This policy adjustment reflected the government’s concerns on the continued acceleration in growth momentum after the release of 2QGDP and June activity data. Given the strong growth momentum in June and the emergence of inflationary, a decisive monetary tightening is a welcome step. It helps restore the central bank’s credibility of inflation control and reduce risks for more painful policy adjustments in the future. However, we continue to believe that reserve requirement adjustment is a blunt and inefficient tool for conducting monetary policy. In the short run, it is effective in reducing excess liquidity and growth of monetary aggregate. However, the past three year experiences in China have shown that its effectiveness tends to be eroded very quickly by continued inflows in FX driven by the undervalued currency. In addition, the excess reserve ratio, stood at 3% as the end of March, and therefore, the 50 bps increase in RRR is not biding on the banks’ capability to lend. This 50 bps hike is the fourth RRR adjustment since August 2003 (a 100 bps hike August 2003, a 50 bps hike in April 2004 and a 50 bps hike in June 2006). It highlights the challenges facing the PBOC to conduct monetary policy under a very open economy and a significantly undervalued currency. In the short run, we expect the reserve requirement hike to assert some downward pressures on the cyclically sensitive China assets, such as banks and commodities. The hike will also likely push up the market interest rates and yield curve in China. However, we do not expect the tightening measures implemented so far to lead to a significant slowdown in growth. We expect money and credit growth continue to soften in the coming months. Goldman Sachs Economic Research China Views 2 Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. 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