SINGAPORE, Sept. 6 (UPI) -- A major change in perception among domestic scholars and officials on whether China should raise interest rates is taking place.
Some investors expect rates to go up in the fourth quarter, particularly as the hawkish governor of the central bank Zhou Xiaochuan has said a few times inflationary pressures have not eased. He has emphasized that although broad money growth has slowed to an appropriate pace, "reserve money growth remained difficult to control due to rapid accumulation of foreign exchange reserves."
He argued that the government needs to continuously "observe and study" the movement of the economy and suggested banks must slow down the rapid growth of long-term loans and prevent short-term loans from being used for long-term investment. But he also reiterated Premier Wen Jiabao's view that loans should be extended to companies, which can 'sell products, generate profits and create jobs.'
Meanwhile, a senior researcher with the Chinese Academy of Social Science, who is close to the monetary policy circle, has also argued publicly that interest rates were "the best tool for macroeconomic adjustment".
"We sense that in the domestic debate on interest rate policy, the balance is gradually tipping towards modest, but not immediate, rate hikes," said Jun Ma, an economist at Deutsche Bank.
"As China moves from deflation to 5 percent year on year plus inflation, a process of normalizing interest rates is inevitable. Political considerations and policy coordination are likely to delay, but not alter, the eventual rate hike outcome," noted Dong Tao, economist at CSFB said.
"We think that Beijing is likely to 'fine-tune' its credit policy with an easing bias towards companies which can sell products, generate profits and create jobs ahead of the party plenum in mid-September. But interest rates are likely to move up in the fourth quarter, with a cumulative 200-300 basis points upside in the following 12-18 months," Tao added.
An increasing number of domestic economists, including influential ones like Ba Shusong a deputy director at the State Development Research Centre, are recommending that rate hikes should be deployed in the next phase of tightening. Last month, Shusong was quoted in the China Securities Journal saying that "if the central bank relies too much on micro-adjustments, these measures might not have hoped-for effects."
The arguments behind raising rates in the fourth quarter are multiple: negative real interest rates have fuelled a bubble in the property market- the property price index was up 11 percent year on year in July, compared with 5 percent in 2003- which has caused a drastic increase in commodity demand and investment, while low deposit rates are driving an increasing amount of domestic savings to bypass the banking system into the kerb market (unofficial trading of stocks or securities away from recognized stock market or outside stock market hours shares) undermining the banking system and creating a huge financial and social risk, economists said.
Meanwhile, the Consumer Price Index is now above 5 percent year-on-year and still rising, while the rate gap between the U.S. dollar and the renminbi has narrowed.
Some economists are still rejecting the idea of raising interest rates, as they believe rate hikes are either ineffective in curbing overheating and investment or not necessary because the economy has already achieved a soft landing.
China policy advisors have also argued that rate hikes will depress consumption. More importantly, the central bank fears depositors' behavior may change due to expectation of inflation as show in the recent halt in deposit growth - month-on-month growth in deposits fell to 0.1 percent in July from 2 percent in June.
"Our view is that, if investment growth does not fall to below 15 percent, and the A share market indices begin to stabilize, the government will entertain the idea of a modest rate hike of 25-50 basis points before the end of the year, and a gradual convergence of the 1-yr deposit rate (currently at 1.98 percent) towards CPI inflation some time next year," said Ma.
"Our view is that Beijing is unlikely to raise interest rates in the next month or so, but the People's Bank of China will likely tighten during the fourth quarter," said Tao, adding "in the near future, Beijing will likely be pre-occupied by the Chinese Communist Party's plenum in September and need more time to assess the recent data trend. However, the need to push up interest rates will probably increase, as investment rebounds, bottlenecks deteriorate and inflation rises."
Tan Hui, economist at Standard Chartered, points that the biggest concern is really the effectiveness of monetary policy in China. The recent surge in inflation was caused by the rise in food prices, and higher interest rates are unlikely to ease such shortages in food, he said. Shortage of land and labor has been a key factor behind the demand/supply imbalance of foodstuffs.
For investment, the cost of borrowing plays a smaller role in the investment decision process compared with the West. "Thus investment growth will be less sensitive to changes in interest rates and only aggressive tightening measures would induce the desired effect. Yet such aggressive measures will also have the negative side effect of dampening the rest of the economy, such as private consumption," Tan pointed.
Tan believed the latest release of softening economic data was reducing central bank urgency to tighten monetary policy and he did not expect the central bank to raise rates this year.
