Fan Gang, professor of economics at Beijing University, explains the need for Chinese sterilization. Here is the abstract: 

While the Fed is pumping more money into the US economy, the
People’s Bank of China (PBC) is trying to reduce the amount of money in
circulation. Money used by commercial banks to satisfy the required reserve
requirement (RRR), which is held in accounts at the PBC, can no longer be
extended as loans. As a result, more money than ever is now frozen or inactive
in China. 

It is understandable that the Fed wants to boost demand as long as the US economy
remains depressed. But why has the PBC tightened monetary policy so much? Inflation
is a concern – having risen to 4.4% year on year in October, from 3.6% in
September. But really, the PBC’s policy is preemptive: sterilize over-liquidity
and get the money supply under control in order to prevent inflation or
over-heating.

At the beginning of the year, the RRR increases could be regarded
as part of efforts to correct the over-supply of money that arose from the
anti-crisis stimulus package. But the most recent RRR increases serve mainly to
sterilize the increase in the money supply caused by the increase in
foreign-exchange reserves.

Indeed, in September 2014 alone, China’s foreign-currency reserves
increased by almost $100 billion compared to August. With the global economy
recovering, China’s
trade surplus began to grow. The rapid growth in foreign-exchange reserves, means
an increase in the domestic money supply, because the PBC issues RMB6.64 (down
3% since June) for every dollar it receives. That means that money supply
increase by nearly RMB700 billion in September. The two 50-basis-point RRR
increases just locked up the same amount of liquidity. The PBC now holds more
than $2.6 trillion in foreign reserves.

The RRR is only one example of a textbook sterilization
instrument. Another is to sell off government bonds held by the central bank in
order to take money out of circulation – again, just the opposite of what the
Fed is now doing. But the PBC sold out its holdings of Chinese government bonds
in 2005. So it had to create something else to sell. It created so-called
“Central Bank Bills,” which commercial banks are supposed to buy voluntarily.
When they do, the money they pay is also locked up in the PBC’s accounts. To
date, up to 5-6% of total liquidity has been returned to the central bank in
this way.

Roughly one-quarter of China’s total monetary base is
illiquid [tied up in RRR]. Thus, although China’s total money supply seems
excessive, with the M2-to-GDP ratio now at about 190%, the real monetary base
is actually much smaller than it appears. As a result, China’s
inflation, as well as asset prices, remain under control. With the Fed’s QE2 on
the table, conditions may worsen before they improve. The PBC may have to
continue its sterilization for some time in the foreseeable future.