Rate-hike speculation swirls through nation
By Chen Yao (China Business Weekly)
Updated: 2004-06-21 14:14

Despite the central bank's warning last week that changes to China's interest rate regime will hinge upon further reports of economic data, investors are continuing to speculate on the timing and impact of a rate hike.

At least, there are signs China has managed to regain control over its overheated sectors, and any mild rate rise in the near future must be the government's last measure in its efforts to ensure the rocketing economy lands softly, economists said.

"A soft landing is far from certain, despite positive signs the authorities' attempts to cool off the economy have started to work," said Peng Longyun, a senior economist with the Asian Development Bank's Beijing office.

Two sets of figures -- one released last week and the other earlier this month -- indicate growth of China's industry output and fixed-asset investment slowed in May, even though domestic inflation increased.

The output of China's industries grew 17.5 per cent, year-on-year, last month, which was slower than the 19.1-per-cent growth in April, indicate figures released by the National Bureau of Statistics (NBS).

Investments in fixed assets -- including infrastructure projects, metal processing plants and automobile factories -- expanded at an annual, 18.3-per-cent pace in May. That was down from the sky-high, 34.7-per-cent recorded in April, NBS reported last week.

However, consumer prices, the inflation barometer, rose to a seven-year high of 4.4 per cent in May. That revived speculation the People's Bank of China (PBOC), the nation's central bank, will soon raise interest rates.

"The interest rate is the central bank's last weapon, held in reserve, to combat inflation. But, unfortunately, it is a two-edged sword ," Peng

said.

RATE: Mild rise may help pilot soft landing

Although interest rate hikes may lower soaring consumer prices, such action could dampen investment in sluggish sectors, and, as a result, cause an immediate shrinkage of liquidity for fund-demanding industries such as real estate, he added.

"Inflation is rising. But it hasn't grown into much of a threat for China's economy, because the meagre 4 per cent is nothing compared with the inflationary rate in excess of 10 per cent in the early 1990s," Peng said.

"My view is China has not yet walked out of the shadow of deflation, which began plaguing the country during the 1997 Asian financial crisis."

Recent surges in domestic price levels are just a "sign of recovery" from relatively low prices over the past six years, and they don't necessarily reflect uncontrollable inflation, NBS said in its report.

Mu Huaipeng, director of the central bank's research division, last week said the bank's decision to raise rates will depend on macroeconomic statistics of at least three months, beginning from June.

Earlier, the central bank's governor, Zhou Xiaochuan, said "bank rates should keep pace with prices."

That was widely interpreted by State media that there would be an interest rate hike in the immediate future.

The Economic Observer newspaper reported on June 13, citing an unnamed PBOC source, the central bank may initially raise the lending rate by 0.5 percentage point and the deposit rate by 0.25 percentage point.

"A mild rate hike, as a tentative measure, might be introduced soon. But, because it would be small, it would not likely have much impact on the economy," Yi Xianrong, an economist with the Chinese Academy of Social Sciences' Institute of Financial Research, said.

Although the central bank is attempting to use the interest rates to control credit in the system, small rate rises are unlikely to dampen investors' enthusiasm for borrowing from banks to finance their investments in the real estate and automobile sectors.

Those two sectors, in recent years, have generated exceptional returns, Yi said.

"Can a 0.5-per-cent rise in banks' lending rates scare off borrowers, especially those who expect to gain annual returns in excess of 20 per cent? Absolutely not," he said.

"Prudent regulations in certain overheated sectors, synchronized with administrative measures, might work more effectively than interest rate rises. Although, in the long run, the changes in interest rates should be prioritized in macroeconomic adjustments."

China's financial authorities, to make interest rates an effective tool of monetary policy, must liberalize the interest rate regime by first widening the floating range of rates, Yi said.

"Otherwise, the lending mechanism of the banking sector will be distorted," he said.

Even though the combined deposits in China's commercial lenders exceeded combined loans by 5 trillion yuan (US$603.8 billion) last year, many enterprises, especially those from the private sector, still cannot access bank loans, he noted.

If PBOC raises interest rates, the bank will probably do it at the beginning of July, around the time the US Federal Reserve (Fed) is expected to raise its rates by a quarter of a percentage point. The Fed is scheduled to meet June 29-30.

"The tightening of US monetary policy will give PBOC much leeway to adjust its interest rates," said Zhang Bin, a financial researcher with the Institute of World Economics and Politics under the Chinese Academy of Social Sciences.

Because the renminbi is virtually pegged to the US dollar, analysts expect both currencies will be adjusted in the same direction, especially given both nations' immediate need to fight off inflationary pressure, he said.

"Authorities' earlier concerns that domestic interest rate hikes may result in greater pressure to revalue the renminbi will be for naught if the United States raises its interest rates first," he added.

Speculation of higher bank rates has weighed on China's domestic share prices, and caused investors to retreat from the market.

China Securities Regulatory Commission statistics, released last week, indicate transactions in the Shanghai and Shenzhen bourses fell 65.5 per cent, from April's peak, in May.

As a result, 106.2 billion yuan (US$12.8 billion) in market capitalization for A and B shares evapourated in May amid concerns of a near-term interest rate hike.

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