China discovers that as they integrate into the global capital market, their interest rates will tend to follow those in the rest of the world. But read a little deeper and find that it's not exactly the standard textbook situation. (NY Times)
HONG KONG, April 27 — China's central bank raised lending rates on Thursday for the first time in a year and a half, in a move by Chinese leaders to rein in the world's fastest-growing economy.
The action aims to slow a spectacular surge in investment and it may potentially brake China's voracious appetite on world markets for oil and other commodities.
With interest rates already climbing in the United States and the European Union, and with monetary officials starting to tighten policy in Japan, China seems to be joining the world's central bankers in trying to gain control of speculation that has driven up prices of assets like gold and real estate.
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"It is easy to borrow money," said Jack Lee, a manager at the Guangchan Conveyor Idlers Company in east central China, which had an 80 percent jump last year in its sales of conveyor belt rollers and is now buying more equipment to open a second production line next year.
China's boom in lending and investment, which has contributed to the country's rapidly rising exports, pushed growth in China's economy to 10.2 percent in the first quarter. That was high even by China's extraordinary standards, and so strong that President Hu Jintao himself warned on April 16 that the country needed efficient, high-quality development and not "excessively rapid economic growth."
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The effectiveness of somewhat higher interest rates in slowing growth, however, remains to be seen. The People's Bank of China, the central bank, said that it was raising the benchmark lending rates on one-year loans by 27-hundredths of a percentage point, to 5.85 percent. It was the same size increase as on Oct. 28, 2004, the last time China raised rates. That increase was the first in nine years.
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But the central bank did not change bank deposit rates. By raising lending rates while leaving deposit rates untouched, the government will allow banks to widen their profit margins to cover losses on loan defaults.
Moreover, by isolating deposit rates, China's move is unlikely to address calls by industrialized countries, including the Group of 7 last weekend, for China's currency to gain in value. One-year bank deposits earn just 2.25 percent in China, and leaving that rate unchanged makes it slightly less attractive for foreign investors to pump money into China and therefore bid up the value of the yuan, the Chinese currency.
Let us not forget that the capital markets in China are not yet totally free of controls.
Also covering the story, Reuters gets some choice quotes:
"It's another example of the Chinese using market instruments to deal with market conditions in their economy," Treasury spokesman Tony Fratto told reporters.
"From that perspective, it's positive, though it's clear that China's ability to use market instruments like the interest rate are somewhat limited because of a lack of flexibility in the currency," he added.
Federal Reserve Chairman Ben Bernanke said later that allowing the yuan to move more freely would give Beijing even more independence in setting monetary policy.
"It's a very large country, they need to have an independent monetary policy. They can't really run independent monetary policy without a flexible exchange rate," he said.
Lorenzo Bini Smaghi, the European Central Bank board member responsible for international relations, called the Chinese move a step in the right direction. Asked in Florence, Italy if more hikes were needed, he replied: "Yes, and they'll do it."
Bernanke's statement becomes more true every time another part of the wall of capital controls is dismantled. As the Chinese move closer to full convertibility, they will need to get those rate in line with the rest of the world. That would imply that more rate hikes are a pretty safe bet. It probably won't be another 18 months before the next one.
UPDATE: The Wall Street Journal has more:
"The underlying problem is the currency," said Hong Liang, chief China economist for Goldman Sachs, who added that the small size of the interest-rate increase made it more likely Beijing would pick up the pace of currency appreciation. China's exchange rate, of course, has been a hot political issue in the U.S. for years, with fierce criticism from manufacturers, unions and others that the yuan is too weak and gives Chinese companies an unfair advantage.
Even if the interest-rate move has little effect on the yuan's strength, according to U.S. economists it signaled that Beijing is increasingly willing to rely on market forces to adjust its economy. Regulators could simply have slowed lending by telling banks they had to keep more money in reserve; instead, they sought to use interest-rate policy much as U.S. or European central bankers would have done.
Indeed. The effect will be small, probably almost undetectable, but it is a sign of things to come.
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