APRIL 28, 2006
Economics
By Pete Engardio
China Taps the Brakes
Beijing's interest-rate hike may signal a greater reliance on market mechanisms to fine-tune its economy
China's suprise move to hike interest rates on Apr. 26 sent a quick jolt through global commodity, currency, and equity markets. Traders fretted that costlier loans in the mainland might cool one of the world's most important growth engines.
Some, though, say such fears are misplaced. "The markets are overreacting," says Goldman Sachs International Vice-Chairman Bob Hormats. "China is trying to slow growth from 10.2% [in the first quarter] to the 9% range, which is still high." That wouldn't be enough to make much difference in global demand for oil, steel, and other goods.
Fixed investment in China now averages nearly half of gross domestic product, an extraordinarily high rate that signals extreme overheating in any nation. So by boosting rates 27 basis points, to 5.85%, China may be able to pull off a moderate, healthy slowdown. "This will have some impact, but not an enormous impact," Hormats says.
RARE MOVE. The real significance of the rate hike may be as an indicator of Beijing's commitment to using market mechanisms -- rather than administrative fiat -- to fine-tune its economy. Until recently, Chinese leaders have been reluctant to tinker with rates at all. The last big rate hike, in 2004, was the first in nine years.
If Beijing policymakers are willing to let bank rates move more freely, Hormats says, they might also be willing to let China's currency fluctuate more freely. China announced last July that it would let the yuan trade in a narrow band against other currencies. But the central bank has let the yuan appreciate by only 3% -- not nearly enough to make a dent in its trade surplus with the U.S., which was $202 billion in 2005. "They could also use a higher currency to tame possible inflation," he says.
One thing Beijing didn't meddle with was the rate on savings deposits, which it left at just 2.25%. "This shows they are worried about consumption," Hormats says. China has declared it wants to boost domestic consumption as part of a strategy to reduce its huge current account surplus.
EXCESS INVESTMENT. Chinese consumers have some $2 trillion in savings stashed in bank accounts, so a higher interest rate would encourage them to save more. Therefore, the rate hike isn't aimed at significantly slowing the real economy, but rather at slowing down excess investment. The net impact of this move is that Chinese banks will enjoy higher margins because the gap between the rates they pay for savings deposits and the rates they charge for loans will grow, Hormats says.
Market incentives alone, though, may not be enough to stop overinvestment. "This doesn't mean Beijing still won't use moral suasion," he says. Indeed, Beijing has been undertaking a number of measures to stop an explosion of new capital investment -- from curbing credit to steel mills to hiking fees for use of government-owned land. China also unveiled "structural adjustment targets" to reduce excess capacity in the cement, coke, and steel-alloy sectors.
Montreal investment strategy firm BCA Research agrees China's rate hikes will have little overall impact. In an Apr. 26 report, BCA said it doesn't see the increase as part of a "new round of credit crackdown" but rather as fine-tuning. "Therefore," BCA concludes, "a broad-based, significant growth slowdown in China is not in the cards."
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