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Comment: Time to rethink monetary policy

By Zhu Qiwen (Business Weekly)
Updated: 2004-08-22 09:54

Like it or not, the US Federal Reserve's second interest rate hike since June will reignite debate in China about the need for the People's Bank of China (PBOC) to take similar action.

Last Tuesday, the US Federal Reserve raised its target interest rate by a quarter point, to 1.5 per cent.

PBOC, China's central bank, may ignore calls for it to take an equally small step in the same direction, out of fear pressure for it to revalue the nation's currency, the renminbi, will linger.

However, the increasing interdependence of China's economy and the world market requires the nation's monetary policy-makers to continue monitoring the big picture - while addressing domestic problems.

It remains uncertain if the second interest rate rise will confirm the US Federal Reserve's resolve to continue its measured pace towards tight monetary policy.

But it does send a clear signal to its Chinese counterpart: The era of cheap money is over.

With its interest rates scraping bottom after consecutive cuts in recent years, China has finally stepped out of deflation's shadow. However, explosive investment growth since last year has forced Chinese authorities to apply the brakes.

In its second-quarter report, published last Monday, PBOC indicated, quite clearly, the focus of China's monetary policies has been shifted to the prevention of inflation.

It is fine for China's monetary authorities to implement stop-gap measures to stem the reckless growth of some overheating sectors, and, in turn, to stave off inflationary pressure.

Nevertheless, without responsive interest rates or a flexible exchange rate regime in their tool box, policy-makers cannot tackle domestic problems effectively, especially as China's economy integrates into the global economy.

China's trade volume topped US$523 billion in the year's first half, which accounted for more than 70 per cent of the nation's gross domestic product.

Given the openness of China's economy, how can domestic consumer prices remain immune to rising international oil prices, which continue to set records? Or how can the flow of foreign funds to domestic industries be cut off?

The State Administration of Foreign Exchange recently warned China's short-term foreign debts had grown to a dangerously high level. That is cause for concern. It indicates some domestic businesses might have tried using foreign funding to circumvent the Chinese Government's macroeconomic adjustment.

Admittedly, the administrative credit tightening has, at least for the moment, cut the flow of bank loans to many fund-thirsty investors. As a result, the breakneck growth in investment, during the first quarter, was reined in during the second quarter.

But that does not mean the underlying investment frenzy among many local governments and domestic enterprises has been affected, as the interest rates remain so low.

While taking stock of the macroeconomic adjustment to determine the next step, China's policy-makers must pay close attention to the costs and limitations of administrative measures implemented from a purely domestic point of view.

The latest interest rate hike in the United States offers China an opportunity to rethink its macroeconomic policy - from a broader perspective.

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