China’s Fourth Short-Term Interest Rate Hike

April 5, 2011

The People’s Bank of China raised the one-year lending rate by 25 basis points to 6.31% and the one-year deposit rate by the same magnitude to 2.25%. Three earlier increases, all by 25 basis points as well, were announced on October 19, December 25, and February 8.  Like December 25 (Christmas) and February 8 (Chinese New Year), monetary officials chose the cloak of a holiday closure — the Qingming Festival — to do their business.  After peaking at 7.47% and 4.14% from December 2007 to December 2008, the lending and deposit rates were reduced five times in the space of just over three months between mid-September 2008 and December 22, 2008 by a total of 216 basis points.

China’s central bank also has raised reserve requirements nine times during the past 13-1/2 months, six times in 2010 and on January 14, February 18, and March 18 of this year, such that large banks are now required to set aside 20% of deposits in reserves.

Aggressive monetary and fiscal policy stimulus enabled China to experience a shallower and shorter slowdown than otherwise would have been the case when the world economy fell apart and to bounce back very sharply in a classic V-shaped business cycle.  But inflation also has heated up, and bank credit expanded excessively.  CPI inflation in the last four reported months to February showed an average on-year increase of 4.9%, while PPI inflation accelerated to 7.2% from 5.0% in October.  Lending shot up 9.6 trillion yuan in 2009, another 7.95 trillion yuan last year, 1.04 trillion yuan this past January, but a smaller-than-expected 536 billion yuan in February.  On-year growth in M2 money averaged 19.4% over the five final months of 2010 but slowed to 15.7% in February 2011.  So some signs have emerged that tighter monetary policy is starting to pay dividends.

Investors continue to fret that monetary officials will over-steer Chinese output and demand, but such fears are probably excessive.  If growth drops substantially enough to impact the world economy adversely, it will not be by intent.  Beijing officials are very mindful of the need to absorb a rising workforce let social unrest develop and clearly want growth to hold above 8.5% and likely 9%.  GDP expanded 10.3% last year and by 9.8% between 4Q09 and 4Q10.  At the trough in 1Q09, on-year growth touched a low of 6.2% but rebounded to 9.1% just two quarters later.

U.S. officials have hoped that tighter monetary policy in China would usher in a faster rate of yuan appreciation.  The dollar was worth CNY 6.645 last October when China’s central bank undertook its first interest rate increase, CNY 6.592 at the end of 2010, and CNY 6.543 at present.  That works out to an annualized 3.4% rate of yuan appreciation since the first rate hike but 2.9% so far this year.  From Washington’s perspective, those advances are very disappointing.  Frustration is magnified by the $199 billion leap in China’s foreign exchange reserves during the final quarter of 2010 and end-year $2.85 trillion level of reserves.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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