Interest rate hike looming in China?
By Chen Yao and Zhao Renfeng (China Business Weekly)
Updated: 2004-08-24 15:34

Although it is unlikely China will respond immediately to the recent interest rate hikes in the United States, and elsewhere, the People's Bank of China (PBOC) is weighing plans to raise interest rates, maybe this year, amid concerns about the country's soaring property prices.

Even if PBOC, the nation's central bank, tightens interest rates as expected, the adjustment will be mild, likely as high as 0.25 percentage point, to minimize the risks of the economy landing hard and to prevent the cooling off of the burgeoning private investments across the country, economists said.

"We are quite certain the central bank will raise interest rates within three-six months, possibly later this year, although it is hard to predict if the central bank will make the moves today or tomorrow," said Tang Min, a senior economist with the Asian Development Bank.

"There are no other opportunities as good as international rate hikes. China's central bank will see it as a reference, but has a lot of discretion to decide the best timing."

Earlier this month, the US Federal Reserve raised its interest rate by a quarter percentage point -- its second rate hike in six weeks -- to 1.5 per cent.

Meanwhile, the Bank of England, the central bank of the United Kingdom, raised its benchmark rate to 4.75 per cent.

Australia has said it will soon increase its interest rate.

"There comes, in the cycle, the new highs of interest rates on international markets," said Yi Xianrong, an economist with the Chinese Academy of Social Sciences.

"This has created a window of opportunity for China to raise interest rates by simply following the trend.

"Because the Chinese capital markets are semi-closed to overseas funds, interest rate rises, as mild as 0.25 base point or so, will unlikely lure ... speculative money into the country."

PBOC is considering using the interest rate leverage to cool off the nation's overheated real estate sector, as domestic property prices are soaring, without signs of slowing down, economists said.

Any moves by PBOC to adjust interest rates must be tentative, and small in scale, to prevent severely affecting the economy, Yi said.

"Higher interest rates will not only affect overheated sectors, but also the sectors that are performing moderately," Tang said.

China's agriculture and service industries have received less investment compared with natural-resource-related sectors and the industries closely associated with the real estate sector, he said.

While fixed-asset investments grew 40 per cent, year-on-year, in China during the year's first quarter, investments in the nation's agriculture sector rose 0.4 per cent.

Meanwhile, China's service sector has not shown, at least thus far, any sign of overheating.

Interest rate hikes could also discourage private investments, which, economists and government officials suggest, would gradually replace government spending as the economy's main driving force.

"Interest rate rises, therefore, will risk causing credit crunches on fund-strapped sectors, while having little influence on already-overheated sectors," Tang added.

China's benchmark, one-year deposit rate is 1.98 per cent; its one-year, lending rate is 5.31 per cent.

"China's central bank will have to raise interest rates to reduce marginal demand in the real estate sector, which has been the most important driving factor in the recent round of economic overheating," Tang said.

He has been a long-time observer of China's economy.

By the end of June, bank loans to the real estate sector had reached 2.1 trillion yuan (US$253 billion), up 36.1 per cent year-on-year.

Meanwhile, new investments in land developments increased 28.7 per cent, indicate statistics.

A recent field survey by the National Bureau of Statistics indicated the average property price in 35 of China's cities increased 10.4 per cent in the year's second quarter compared with a year ago. In Shanghai, meanwhile, the growth figure reached an astonishing 20 per cent.

"The unusual upswing of property prices has caused prices in related sectors, including steel, cement and aluminium, to increase rapidly," Yi said.

"Although the central government has been tightening regulations ... in the steel, cement and aluminium sectors, unquenched demand in the real estate sector will eventually drive up prices in those industries."

In July, steel prices rose 2.1 per cent from June. That was up 18 per cent from a year ago, indicate PBOC figures.

Meanwhile, the price of cement rose 4.7 per cent from June, and 11.6 per cent year-on-year, the central bank said.

PBOC noted in its quarterly report on monetary policy that its credit-tightening measures have prevented new investments in the real estate sector, but failed to influence the demand side.

"As investments and new projects in land development continue to decline, demand will consequently exceed supply. This will push property prices up," the central bank wrote in the report.

PBOC must deal with the demand side in the real estate sector to effectively bring down property prices, Yi said.

"This means the central bank is unlikely to drop the option of raising interest rates ... The surging demand in the sector will only be quenched in this way," he said.

The recent interest rate hikes in the United States, however, are unlikely to cause an outflow of speculative funds, or hot money, from China, economists said.

"A 0.25-percentage-point increase in the interest rate in the United States will not make hot money leave China. Even a 1-percentage-point rise would not be big enough to make hot money leave China," said Martin Feldstein, president of the National Bureau of Economic Research in the United States.

Feldstein is also a professor of economics with Harvard University.

China's rigid currency regime and tight control over capital accounts means speculative funds will, over the short term, have trouble finding a way to benefit from the abrupt rate rises in the United States, he said.

Uncertainties over whether PBOC will follow suit has left speculators in the unenviable position of not being able to quickly make their decisions, Feldstein said.

A rate change would not affect foreign direct investments (FDI) into China, as FDI generally are for the long term, he said.

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