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Responding to fears of asset bubbles, inflation and an overheating economy, China has reined in lending for the second time in a month, ordering banks to increase their reserves on the eve of Chinese New Year celebrations.

Beijing's decision to boost lending constraints raised the spectre of a pullback in a red-hot domestic property market as well as in commodity prices, which have been boosted by China's loose lending policies.

Oil and metals prices retreated Friday on concerns that Chinese demand, a key commodity price factor, will fall. The resource-driven Canadian dollar slipped five basis points to close at 95.08 cents U.S.

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Chinese banks were ordered Friday to increase their reserves by half a percentage point. Large financial institutions must now keep 16.5 per cent of their outstanding loans in reserve. Smaller banks must keep 14.5 per cent.

"Not only are they trying to rein in the amount of lending, they are also trying to improve the quality of the lending so it isn't simply being directed towards speculative activities but more towards productive elements of the economy," Nick Chamie, the global head of emerging markets research at RBC Dominion Securities, said in an interview.

Chinese banks lent a record 9.6-trillion yuan ($1.5-trillion) last year in an effort to keep China's economy humming amid the global economic downturn. The liquidity surge helped China post GDP growth of 10.7 per cent in the fourth quarter but has also stoked fears about asset bubbles in Chinese housing prices and in some commodity markets. Lending surged in the first two weeks of January before banks were told to reduce lending. They are targeting 7.5-trillion yuan worth of loans this year.

Mr. Chamie said Beijing's measured response to the extremely loose lending policies should help China avoid a boom and bust scenario. However, the overheated property and resource sectors could still cause problems.

"Once this huge credit boom tide has rolled in and then moves back out, it may unearth some surprises for investors and markets relating to either real estate markets or commodities. Investors should be attuned to those risks," Mr. Chamie said.

Beata Caranci, director of economic forecasting at Toronto-Dominion Bank, said Chinese policy makers have further options to keep the economy from overheating due to excessive liquidity.

Ms. Caranci expects another 50-basis-point increase in reserve requirements to be implemented in the second half of the year. China could also boost interest rates or let its currency appreciate to cool the economy, she said.

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Asia-Pacific Reporter

An award-winning journalist, Andy Hoffman is the Asia-Pacific Reporter for Canada's national newspaper, The Globe and Mail. More

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