Interest rate rise seen to tighten monetary policy


Updated Mon, 08 May 2006 00:00:00 GMT

China's latest interest-rate hike will likely herald a new round of monetary tightening as early as this month aimed at curbing red-hot investments and growth in loans to more sustainable rates, economists said.

The Chinese central bank's recent raising of its lending interest rates before the weeklong Labor Day holiday was meant to give markets a break to digest its significance during the vacation when stock, foreign exchange and commodities markets were all closed.

The People's Bank of China raised its benchmark lending interest rates on April 28, the first rise since October 2004, as it sought to maintain a healthy growth of the economy.

The benchmark rate for one-year loans was raised to 5.85 percent from 5.58 percent, up 0.27 percentage point. Apart from the 0.28 percentage point hike in the six-month rate, other lending rates went up 0.27 percent.

"We believe the central bank is trying to send a strong signal that the authorities mean business when it comes to controlling overheating in the economy and overinvestment," said Stephen Green, a Shanghai-based senior economist at Standard Chartered Bank, in a note.

Ma Jun, an economist at Deutsche Bank, said the rate hike is in fact an official announcement that the monetary authorities have shifted its policy stance from "neutral" to "tight."

Analysts believe last month's interest hike won't be a loner since its power to cool the booming economy, which grew an average 9.7 percent in the past 27 years, is limited although it had brought a strong psychological impact.

A booming credit, which had contributed largely to overinvestment in some sectors, was among the central government's major concerns.

Fresh yuan-denominated loans jumped 70 percent in the first three months to 1.26 trillion yuan, accounting for more than half of the government's 2.5 trillion yuan target for the whole year.

The authorities will probably raise borrowing costs again or ask lenders to set aside more reserves if investments remain strong, analysts said. An increase in banks' cash reserves, which had been speculated in the markets for more than a month, is expected to be implemented this month.

"It is possible that the rate hike will be followed by more tightening measures, including a hike in the bank reserve requirement ratio or moral persuasion on the banks to curb credit," said Rob Subbaraman and Wenzhong Fan, economists at Lehman Brothers, in a note.

"However, in our opinion, the aim of China's policy-makers is not to slow the economy sharply; rather it is to improve the quality of growth, rebalancing it away from wasteful investment, and toward consumption."

The central bank last month left unchanged its one-year deposit rate at 2.25 percent, in a bid analysts see to prompt domestic consumer spending while beating down pressure of a speculative funds influx.

Raising the banks' reserve requirement ratio by 0.5 or 1 percentage point from the current 7.5 percent will help tighten the excess liquidity, economists said, while inspecting the banks' loan structure may avoid diverting lending to sectors already showing signs of overcapacity.

More curbs

More curbs on the property market are also on the horizon as some analysts say housing prices tend to rebound on the back of abundant money flows.

Housing prices in 70 large and medium Chinese cities rose an average of 5.5 percent in the first quarter from a year earlier after several months of dips, the National Development and Reform Commission's recent report shows.

The authorities issued rules last month, requiring developers to pay fees if they halt construction for more than a year when their construction is less than one third of the total floor area or the investment pumped in is less than 25 percent of the total.

The commission is also expected to unveil a policy to cool more red hot industries. Plans to consolidate the cement, aluminum and steel industries have already been announced this year.

China's steel, aluminum, auto, coke and coal sectors are burdened amid oversupply. For instance, over 60 percent of the aluminum makers are losing money with a combined capacity of 2.6 million tons being unused due to the oversupply.

China's economy maintained its blistering growth of 10.2 percent in the first quarter due to rising investments. Fixed asset investment, including those on factories and infrastructure projects, jumped 27.7 percent in the quarter, outpacing a full-year target of 18 percent growth.

M2, which includes all cash and bank deposits, jumped 18.8 percent on-year to 31.1 trillion yuan as of March 31, 4.7 percentage points higher than a year before and topping the government's 16 percent target for 2006.

Economists expected this year's tightening package, including the rate hike, will have an impact on such growth and slow demand increase for construction materials including steel, cement, aluminum and chemicals.