SINGAPORE, April 13 (UPI) -- The Chinese government is becoming increasingly serious about taking preemptive measures to cool off the overheated economy. The central bank has just tightened credit again and although this latest move will be insufficient to refrain the investment rush, it is certainly heralding further tightening with a rise in interest rates probably next in the cards.
Just two weeks after raising the deposit reserve requirement ratio for banks, the People's Bank of China announced another rise from 7 percent to 7.5 percent (the third since August).
The move came at a time when there are more evidences showing that the economy is not slowing down. Industrial production jumped 19.4 percent in the first quarter, while imports sky-rocketed 42 percent, despite the fact that money supply growth has already started decelerating in the first two months of this year.
It is also reportedly suggested that several provinces -- high growth provinces such as Jiangsu, Zhejiang and Shandong -- are under-reporting their first quarter GDP growth figure by as full as two full percentage points.
The current investment bubble is becoming bigger than the one between 1992-1994. Gross fixed investment adjusted for inflation grew by 35 percent in 1993 but is running at about 45 percent now, says Andy Xie, economist at Morgan Stanley. A vast property bubble centered on Shanghai and Beijing is driving the current investment boom, while the rapid growth of investment in commodity industries is due to the high commodity prices driven by the property bubble.
"Investors started far more projects than expected, most likely with the collusion of local governments, in the first quarter, hoping that the
banking system would have to feed what had already started regardless of
the tightening policy," Xie said. "This moral hazard problem has increased
substantially the risk of a hard landing for China's economy."
Xie added, "It is extremely difficult, if not impossible, to guide fixed investment from 50 percent annual growth at present to the trend rate of about 10-12 percent."
Yet, economists are encouraged by the central bank's latest move, even though they believe the tightening is insufficient.
"The significance of this tightening is not the rate itself, but the statement from the central bank. It clearly stated the risk of the inflation/asset bubble, new non-performing loans and the threat on financial stability," says CSFB economist Dong Tao. "Beijing is no longer shy from referring to the fast investment and strong loan growth as a bubble. With that important change in tone, tightening will continue, and probably escalate, until investment and loan growth are back to more sustainable levels."
Chris Leung, analyst at DBS Bank notes that the second quarter is usually characterized by high investment and loan growth.
"Should we continue seeing fixed asset investment, import, industrial production and loan/money supply to persistently grow at a torrid pace in the second quarter, the next move from the central bank will be more drastic such as raising the reserve requirement ratio to 9 percent from 7.5 percent at one go," Leung predicts.
At this stage, the central bank appears still reluctant to raise interest rates, but many economists believe it is only a matter of time before "cross-the-broad" tightening kicks in.
Supply side bottlenecks in power, transportation and commodities are deteriorating quickly. "After converting the bottlenecks into pricing pressure, we estimate that the Chinese economy is running at an inflation rate close to 8-10 percent instead of official 2-3 percent," Tao says.
With inflation on the rise, China is quickly slipping into negative interest rates.
"With Beijing sounding increasingly hawkish on reining investment, we think our call for an interest rate hike around mid-year is well on track. We do not think the central bank will tighten imminently, because the government wants to allow some time to see whether this round of reserve requirement tightening is effective," said Tao.
When rate hikes start, Tao suspects the scope of tightening could surprise the market.
"We look for 200 basis points within 18 months starting from mid-2004. This should put heavy pressure on highly geared companies, as well as the property market. Along with a Zhu Rongji style of austerity program, we expect investment growth to fall sharply. However, the overall economy is likely to achieve a soft-landing on the back of consumption and export strength," he says.
