China should stop relying on reserve requirements as a tool to fight inflation and lean more on interest rates instead, a senior researcher at a government think-tank said on Wednesday.
Liu Yuhui, a researcher at the Chinese Academy of Social Sciences, said China cannot calm inflation just by raising the reserve requirement ratio because that does not pull real interest rates out of negative territory.
Liu's view directly counters the official stance of China's central bank, where top officials have signalled in recent days that increasing the reserve requirement ratio may still be its primary policy tool of choice.
"China should change its monetary policy tool-kit as soon as possible," Liu said in an article published in the official China Securities Journal.
"In not daring to substantially change monetary conditions by raising interest rates, policies are now in a difficult situation and the negative impact is building up," Liu said in an article published in the official China Securities Journal.
Some economists such as Liu believe China is not tackling its inflation woes so long as it has negative real interest rates, since that encourages investors to put their money in asset markets and add to price pressures.
With China's 2011 inflation target at 4 percent and one-year deposit rates at 3.25 percent, its inflation-adjusted interest rates stand at -0.75 percent.
Worse, real rates could sink further into negative territory since many analysts believe China will breach its annual inflation target for the year.
To curb rising price pressures, China has lifted the reserve requirement ratio for banks seven times since November, or by 350 basis points, to a record high of 20.5 percent.
It has been more reluctant to raise interest rates for fear that sharp increases in borrowing costs could stall the world's second-largest economy and attract further inflows of speculative money.
By tightening reserve requirements and ordering banks to lock up deposits they would otherwise have lent, China hopes to drain its economy of the excess money.
Abundant liquidity is one of the main drivers of China's 32-month high inflation, alongside food and property prices.
In a possible hint that China will continue to use reserve requirements as the main tool to manage liquidity, Zhou Xiaochuan, China's central bank chief, said on Saturday there is no limit to how far the ratio can climb.
Hu Xiaolian, the central bank's deputy governor, also said there is "considerable" room left for raising the reserve ratio. She made her remarks two days before China lifted the ratio on Sunday by 50 basis points.
