Download Interest rate rise cannot cool China`s economy

INTEREST RATE RISE CANNOT COOL CHINA'S ECONOMY
Chen-yuan Tung
Taipei Times
11/5/2004, P. 8
On October 28, the People's Bank of China announced it would raise the one-year
interest rate by 0.27 percent -- the first rate hike in over nine years. Why did China
raise its interest rate? Will it continue to raise the rate? Will this affect the yuan's
exchange rate?
Basically, there are three reasons behind the rate hike. First, the speedy growth in
"investment in fixed assets" that has overheated China's economy has not been
completely reined in, showing that Beijing's macroeconomic control measures have
not yet cooled down the overheated economic growth. Total investment in fixed
assets grew by 26.7 percent last year, and by 43.5 percent to its highest peak in March,
causing much concern about the economy. After Beijing officially launched its new
control measures in April, investment still grew by 30.3 percent in the first eight
months.
Second, inflation pressure is still high. China's inflation rate jumped 4.2 percent points
within a year -- hitting 5.3 percent in July and August, from only 1.1 percent last
September. Although the Chinese government claims that higher food prices, which
trigger inflation, will decline after the abundant autumn harvest, no major price drop
has yet been seen. On the contrary, growth in prices for non-food items gradually
increased to 1 percent in August from 0.1 percent in January, as China's overall price
levels remain high.
Moreover, as international oil prices move above US$50 a barrel, this has caused
prices of Chinese commodities to climb. Viewing the latest figure in August, Chinese
commodity prices grew were up 6.8 to 12.9 percent from the same period last year.
Third, people's savings have continuously dropped, decreasing banks' liquid funds and
increasing financial risk. Due to inflation, seen since last October, the actual one-year
deposit rate has become negative, sinking to minus 3.72 percent in August. As a result
of the negative figure, growth in deposits has slipped month by month, and savings
grew by a mere 15.3 percent in August, which was 4.7 percent lower than the rate in
August of last year, marking seven months of consecutive decline.
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Between June and September, the US raised its interest rate three times, or a total of
0.75 percent, providing a good external environment for China's rate hike. Still, the
0.27-percent hike may not resolve the cause of the overheated economy: massive
foreign exchange that is flooding into China's market due to its low exchange rate.
Since last year, the People's Bank of China has been forced to absorb more than
US$10 billion of foreign exchange every month to maintain the fixed exchange rate.
The amount in July was still as high as US$12.4 billion. This phenomenon has
seriously interfered with the autonomy of China's currency policy.
Additionally, China's "unidentified" foreign exchange reached US$50.3 billion in late
August, which was US$17.6 billion, or 53.8 percent, higher than that of the same
period last year. Rampant "hot money" in China may become even worse this year.
The 0.27-percent hike was indeed insignificant. It does little to relieve inflation
pressure, not to mention that investors may expect more rate hikes in the future. Such
expectations will bring more money into China's market, and will increase
appreciation pressure on the yuan.
So the rate hike can hardly cool down the overheated economy. It will lead to greater
expectation for the yuan's appreciation, and even more foreign exchange will flow
into the market, overheating the economy while causing a new wave of pressure for
more interest rate hikes.
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