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At last, China raises interest rates to cool economy
By Jamil Anderlini

SHANGHAI - In a surprise move, China’s central bank has announced it was raising the benchmark lending and deposit interest rates by 0.27 percentage points each, effective immediately. The benchmark one-year lending rate increased from 5.31% to 5.58% and the one-year rate on bank deposits rose from 1.98% to 2.25%.

The country's first interest rates rise in nine years, announced Thursday, contrasted sharply with the well-signaled, steady rises that are happening in more developed economies, and the move caused financial markets around the world to sit up and take notice. United States stocks and metal prices initially fell on fears of slowing global economic growth (up to two-thirds of which has been attributed to China in the past year or so) and the US dollar rose as investors bet that a slowdown in China would weaken commodity prices and hurt the rest of Asia, especially Japan.

Even officials in the administration of US President George W Bush administration, involved in the hectic buildup to next week's presidential election, seized on the news as proof that China was preparing to alter the yuan's peg to the dollar, due, they claimed, to pressure applied by Treasury Secretary John Snow. Chinese officials and most analysts, however, said the rate rise was intended simply to cool inflation and had nothing to do with any plans to revalue China's currency.

The strong reaction to what is really quite a small increase is proof of how much more integrated China's economy is now with the rest of the world and how important it is as an engine of world growth. But worries that a Chinese rate rise signals a global slowdown are unfounded and reflect the knee-jerk nature of the markets more than anything else. The hike is just a continuation of a policy that aims to cool the economy to avoid a crash.

Despite growth that is still very high, at 9.1% in the third quarter, China appears to be in the middle of a much-touted "soft landing", thanks to the mainly administrative measures the government has introduced over the last year to cool the overheating in certain sectors. The rate rise is significant in that it shows the government is still concerned about inflation (which dropped slightly in September but remained high at 5.2%) and the resulting negative real interest rates for bank deposits that have encouraged many to withdraw deposits and invest in more speculative assets, such as property.

The rise also allows the People's Bank of China (PBOC) to signal its commitment and political mandate to raise interest rates further if inflation remains high. But most observers do not expect a total hike of more than 0.50%. According to PBOC and analysts' reports, inflation has already leveled off and should fall to more sustainable levels by next year. The government is wary about raising rates too high because of fears that large speculative inflows will increase pressure on China’s currency to be revalued and there are strong voices within the leadership that feel tightening measures have already been too effective.

Of more long-term significance than the rise in benchmark interest rates was the simultaneous announcement that the PBOC had raised the restrictive ceiling on lending rates. Banks can now charge up to nearly 14% per annum on loans. This is unlikely to have any great effect in the short term because Chinese banks still have a lot of money to lend and this puts downward pressure on rates. But what it means for the future is more freedom to set a price on the risk of being repaid the money they lend. This is crucial to the healthy development of China's decidedly unhealthy banking system, which still tends to lend money based on political, rather than economic, considerations.

On its website, the PBOC said that giving the banks the ability to price risk will allow more capital to be allocated to the private, small- and medium-sized enterprises in China, which often have trouble getting access to credit despite their generally higher asset quality. In the long run, this is far more important than a relatively small rise in interest rates.

Jamil Anderlini is the former editor of China Economic Review. He can be reached at

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Oct 30, 2004
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