China's Rate Boost Shows Economy's Vigor
By JAMES T. AREDDY
March 19, 2007; Page A2
SHANGHAI -- The decision by China's central bank to raise interest rates for the first time since mid-2006 to temper investment and steady the financial system serves as a reminder of how vigorous the nation's growth remains even as clouds form over the economies of Beijing's major trading partners.
The People's Bank of China said the 0.27-percentage-point increase will push the benchmark one-year lending rate to 6.39% and the one-year deposit rate to 2.79%. The higher interest rates took effect yesterday.
The central bank noted in a statement Saturday that it aims for an economy that grows "both well and fast."
In recent days, Beijing had raised market expectations for higher interest rates by reporting economic data that indicated bank lending and investment in the first months of the year were exceeding targets.
On Friday, fresh rumors of tighter credit dented Chinese shares, with the benchmark Shanghai Composite Index slipping 0.7% to 2930.48. Higher lending rates will raise borrowing costs for companies and individuals with mortgages, while the deposit-rate increase could further damage stock prices -- now near record highs -- by making bank savings look more attractive.
China only reluctantly adjusts base interest rates. More often, to damp lending and investment, authorities pressure state-controlled banks or make technical adjustments to their capital requirements. Still, interest rates are expected to become a more important policy tool as Beijing introduces more market orientation to its financial system and capital markets.
"In our view, raising both the deposit and lending rates is a much more efficient and effective measure of monetary tightening than a reserve requirement ratio hike or intensive moral suasion on bank lending," Hong Liang, a Goldman Sachs economist, said in a statement that welcomed the move as "positive."
After the credit tightening, Ms. Hong said she expects authorities in China to use additional technical measures to draw liquidity from the financial system, as well as possibly raise interest rates again, while continuing to have the Chinese currency strengthen against the U.S. dollar.
Beijing's credit tightening is a reminder of how disconnected China's financial system is from those elsewhere. Despite its emergence as one of the world's largest trading economies, China's closed capital markets and other controls give it room to pursue interest-rate policy independently. But Beijing's policy making also has appeared to defy textbook economics, which hold that a country can control two -- but not all three -- of these policies: exchange rates, interest rates and flow of capital across its borders.
The latest interest-rate increase was only Beijing's fourth such move since 2004, and it took the cumulative increase to 1.08 percentage points. By contrast, the two-year cycle of tightening in the U.S. that began in mid-2004 saw the Federal Reserve raise short-term interest rates 17 times, by a total of 4.25 percentage points.
Furthermore, China's latest move comes as economists predict U.S. interest rates will be lowered this year, amid concern problems in the U.S. mortgage market and elsewhere in the economy could hamper growth. Doubts are growing among economists about whether there will be further rate increases by China's biggest trading partner, the European Union, and by its neighbor, Japan.
China is acting now to contain economic growth that has barreled ahead this decade, with gross-domestic-product expansion topping 10% in each of the past four years. Economists say Beijing is increasingly having trouble keeping inflation pressures in check. The government says it aims to keep GDP growth close to 8% in 2007 and consumer-price inflation below 3%.
Many economists regard China's tight grip on the value of its yuan as an underlying reason for policy makers' concern about financial-system stability. Foreign reserves now top $1 trillion and underscore how China's weak currency has drawn funds into the country, partly by keeping exports inexpensive. The trends have left Chinese banks flush with funds to lend out, a situation that risks bumping up inflation and leaving banks holding bad loans.
In Saturday's statement, the People's Bank of China said the rate change has various goals: "leading a reasonable growth of credit and investment, maintaining basic stability of prices, steady and healthy operation of the financial system, balanced economic development and structure optimization, as well as promoting the national economy to develop both well and fast."
It is typical for Beijing to adjust one-year interest rates by a margin of 0.27 percentage point. Lending rates were increased by that amount most recently in August 2006, April 2006 and -- in the first rate increase since the mid-1990s -- October 2004. |
