Serious inflation would harm the interests of the people and the central bank needs to improve its monetary policy decision making in order to maintain the stability of the currency's value, a top central banker has said.

"Instability in the value of the currency, inflation, especially serious inflation, will significantly erode the interests of the people," a press release by the central People's Bank of China (PBOC) on Monday quoted PBOC Governor Zhou Xiaochuan as saying.

Experience shows inflation surfaces at least half a year after "excessive growth" in money supply is reported, Zhou said.

It takes a longer period of time for inflationary pressures to translate into price bubbles on assets such as properties and stocks, which is a far more destructive consequence, he said.

As Chinese commercial banks have been quick in granting new loans, largely as a result of a recovery in economic activity, M2, the broad measure of money supply that includes cash in circulation and all deposits, soared by 20.8 per cent on a year-on-year basis to 20.5 trillion yuan (US$2.5 trillion) at the end of June, the fastest pace in six years.

In both its May and June monetary policy reports, the PBOC said the money supply growth was "on the fast side."

In its May report, the bank said it was considering raising the mandatory deposit reserve ratio, or the amount of deposits commercial banks are required to put in the central bank.

The news prompted opposition from some economists who say the move may cause an unwanted sharp slowdown in money supply growth and erode the momentum of economic growth. The bank stopped short of mentioning the move in its June report, leaving the market wondering what it had up its sleeve.

In Monday's press release, Zhou said the key to preventing serious inflation is the central bank enhancing its "foresight and scientific approach" in monetary policy making.

The PBOC has been scaling up its open market operations this year to absorb excess cash despite differing opinions among economists over whether the money supply growth has been too fast, but the effect has so far appeared undesirable.

Zhou said monetary policy should also play a bigger role in the allocation of financial resources.

Some glaring problems, including the high bad loan ratios at banks and the price-rigging in the stock market, are all related to misallocation of financial resources, he said.

To meet allocation goals, the governor said the central bank needs to press ahead with the interest rate reform to "gradually form a reasonable pricing mechanism."

(HK Edition 07/30/2003 page7)

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