Business Standard

More surprise than rise

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John Foley

China: China’s first rate hike since 2007 sounds more momentous than it is. But the modesty of the 0.25 percentage point move means there’s scope for more substantial action on China’s too-cheap currency.

There are two good reasons for China to tighten, namely to remedy negative real interest rates and to curb runaway property prices. The new higher deposit and lending rates – 2.5 per cent and 5.56 per cent, respectively – won't really do either. Consider the negative real rates. The central bank’s action will at best take the edge off stirring inflation, but the maximum allowable reward for holding deposits is still below the targeted inflation rate of three per cent. Depositors’ own inflation expectations are likely to be much higher. China's savings are still being bled away.

 

Dwindling savings have driven depositors back to real-estate speculation, but the rate hikes won’t be enough to call them back. Urban property prices increased 9.1 per cent year on year in September, and total transactions by value were up more than 50 per cent from August. Raising interest rates might threaten a property crash if buyers were highly mortgaged, but they are not. Moreover, the expectation of property gains is now so engrained that a tiny rise in rates is unlikely to dampen the mania. Still, just because the rate hikes are a baby step, that doesn’t render them pointless.

GDP and inflation data due on October 21 are likely to show that demand remains strong, and price pressures are rising. Money growth in August was up a worrying 19 per cent year on year. And for a country whose GDP is likely to grow at 10 percent this year, China’s rates are still low in absolute terms. There is room for more tightening, and of the kind that both China’s consumers and trade partners really need.

Beijing can help control inflation by allowing the currency to appreciate, putting a dampener on commodity and other input prices. That would make Chinese exporters less competitive, but not deter the budding consumers the country hopes to promote. A stronger yuan is what almost all of China’s trade partners crave, especially given the currency’s recent falls against almost all of its major counterparties. By raising rates just a little, Beijing may have left itself room for a welcome sequel.

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First Published: Oct 21 2010 | 12:13 AM IST

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