IE 11 is not supported. For an optimal experience visit our site on another browser.

China raises lending rate to slow economy

China raised interest rates for the first time in 18 months on Thursday to slow a boom in credit and investment that risks destabilizing the world’s fastest-growing major economy.
/ Source: Reuters

China raised interest rates for the first time in 18 months on Thursday to slow a boom in credit and investment that risks destabilizing the world’s fastest-growing major economy.

In a move which took global markets by surprise, hitting shares and metals prices and briefly boosting Japan’s yen, the central bank raised its benchmark one-year lending rate to 5.85 percent from 5.58 percent. However, it kept its deposit rate unchanged at 2.25 percent.

The central bank also issued guidelines to commercial banks designed to control lending to about a dozen industries where capacity swamps demand.

“The increase in the lending rate is aimed at further strengthening the fruits of macro controls and keeping solid momentum for the economy to grow in a continuous, rapid, coordinated and healthy manner,” the bank said in a statement.

Most economists had expected the central bank, which announced the move on its Web Site, to require banks to lock up more cash in reserve as the first step towards curbing credit growth.

“This is very unexpected. The market was anticipating a hike in reserve deposit ratios,” said Ben Simpfendorfer, a strategist with Royal Bank of Scotland in Hong Kong.

But he added: “It’s a positive step in so far as it should help take some of the steam out of investment demand. It also signals a proactive central bank.”

The case for tighter policy was sealed after first-quarter figures showed annual gross domestic product growth accelerated to 10.2 percent from 9.9 percent in the fourth quarter of 2005.

Annual fixed-asset investment growth picked up to 27.7 percent from 25.7 percent in all of 2005, while banks extended 1.26 trillion yuan in new loans in the first quarter — more than half the central bank’s target for the whole year.

Lorenzo Bini Smaghi, the European Central Bank board member responsible for international relations, called the Chinese move a step in the right direction. Asked in Florence, Italy if more hikes were needed, he replied: “Yes, and they’ll do it.”

However, Tim Condon with ING Financial Markets in Singapore said he was surprised at the central bank’s choice of tightening tool because the last increase in lending rates, in October 2004, had scant impact in cooling the economy.

“So I am kind of skeptical this one will either, but it does show the authorities’ determination to rein in some of that liquidity,” Condon said.

More tightening to come
Like others, Condon expects the authorities to weigh in with other steps before long.

“The government and central bank are determined to tighten and if they don’t see the target being met, there could be more measures coming,” said Jun Ma, a Deutsche Bank economist in Hong Kong.

Zhu Jianfang, chief economist at China Securities in Beijing, added: “I’m quite sure that there must be more measures to be rolled out in coming weeks to drain extra cash from the banking system because, with the lending rate increasing while the deposit rate remain unchanged, the wider gap will encourage banks to lend more.”

Metal prices, which have rocketed recently partly in reaction to booming demand from Chinese industry, fall back on the news.

Gold which hit an intra-day high of $642.10 an ounce was quoted at $627.20/628.20 by 1230 GMT while zinc fell 6.3 percent to $3,150 a tonne on the London Metal Exchange.

European share prices, already weak, fell further, with the FTSEurofirst 300 index off 1.07 percent and the yen approached three month highs against the dollar before losing its gains on verbal intervention from Japan’s top financial diplomat.

Investment is booming because China is awash with cheap money from its record trade surplus, which tripled last year to $102 billion; from foreign direct investment exceeding $1 billion a week; and from speculative inflows betting on a stronger yuan.

The Group of Seven industrial nations urged China last weekend to redress this imbalance by letting the yuan (CNY-CFXS) rise faster. So far the central bank has let it edge up just 1.2 percent since revaluing it by 2.1 percent last July and unshackling it from a decade-old dollar peg.

But Beijing has conspicuously held the yuan down this week, despite the G7 statement, and Wang Chuanglian, an economist with Great Wall Fund Management in Shenzhen, said it was no accident that the central bank had not raised deposit rates, which could have attracted more unwanted capital inflows.

“The central bank is reluctant to raise deposit rates because of its concerns over the yuan,” he said.

Yet many economists believe a stronger yuan will have to be part of the solution to restoring balance to the economy.

Partly because Beijing has been reluctant to let the currency rise, fearing job losses in export industries, it has had to keep the cost of money far too low for such a fast-growing economy.