No real reason to hike interest rates
By Wang Wu (Bsiness Weekly)
Updated: 2004-07-26 13:57

Since China's economy showed some signs of overheating at the end of last year, rumours about a possible rise in interest rates have not waned. Some economists are again calling for hikes.

China's interest rates have either been cut or kept at low levels for many years -- at least since the People's Bank of China (PBOC), the nation's central bank, raised them in 1995. Therefore, it is natural that people would think of raising interest rates at the first hint of inflation.

However, there does not appear to be a compelling reason for PBOC to make such a decision, especially hastily, at the present time.

PBOC may have had such plans, but recent changes in the situation have rendered it unnecessary -- for the time being.

The strongest argument for raising interest rates is that the consumer price index (CPI) reached 5 per cent by the end of June, a level generally believed to herald inflation. That is much higher than banks' deposit rates, and very close to rates for loans. Interest rates would normally be raised in such cases.

Reality, however, often contradicts reasoning.

Experts with the National Bureau of Statistics (NBS) attributed 4.4 percentage points in the 5-per-cent CPI increase to the price rise of food. That hike was the result of the central government's moves to fatten farmers' incomes.

Higher incomes for farmers is a blessing for the national economy, not an indication of inflation.

The CPI rise in June was also a delayed effect of price hikes of non-food products during last year's fourth quarter. The causes that triggered that hike have diminished as a result of the nation's efforts, late last year and early this year, to cool down some overheated sectors.

It is likely the CPI will drop in the next few months, probably to 3 or 4 per cent. That should be regarded as a return to normal, given the fact the CPI growth was low, or even near zero, in recent years.

The national economy showed signs of overheating at the beginning of the year. That was probably the right time to raise interest rates. The government chose several administrative measures to chill the fever in some industrial sectors, but refrained from raising interest rates.

Matters in China are always complicated. Overheating in some industrial sectors was caused by overinvestment by local governments or government-favoured enterprises. A higher loan interest rate would have done little to deter those governments from borrowing money.

But raising the interest rates on loans would have greatly affected small and medium-sized non-governmental enterprises. That explains, in addition to other considerations, why the central government hesitated to use the magic wand to repel inflation.

Counter-overheating measures taken by the government have taken effect, and investment in some sectors have ebbed and prices of some materials, such as steel and cement, have dropped.

The measures unavoidably have led to some unwanted side effects -- non-government investment has been stymied. In some places, Fujian Province for example, some private companies have had to receive loans from private banking houses -- with interest rates as high as 12 per cent.

Under such circumstances, the central bank has even less reason to raise interest rates.

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