On Friday, the People's Bank of China and the State Council
launched a coordinated move to pull the blistering economy on to a
sound track of development.
The central bank raised the benchmark one-year deposit and
lending rates of commercial banks by 0.27 percentage points,
effective from Saturday, and the State Council decided to cut the
income tax from bank deposit interests from 20 percent to 5 percent
since August 15.
The two major policy moves are aimed at realizing a reasonable
growth in bank credits and investment, easing the inflation
pressure and maintaining a stable price level for the country.
The market has long been expecting the policy adjustment.
According to the official statistics on the economic performance
from April to June, GDP grew by 11.9 percent, investment in estate
development rose by 28.5 percent, while the CPI was up by 4.4
percent in June. All these figures indicate probable economic
overheating.
The dual adjustments regarding interest came after the
authorities had a better vision on the role of interest rates in
the financial market.
The Monetary Policy Committee under the central bank, after its
second quarterly meeting held early this month, said "the sound
monetary policy featuring a steady and moderate tightening should
be continued" according to the current situation of the
economy.
Meanwhile, it also stressed that "development of the money
market benchmark interest rate system should be accelerated to
further increase the role of price in macro financial
management".
Central bank officials were also heard expressing their concern
openly that a negative actual interest rate might threaten the
sustainable economic growth and the government has the
responsibility to lift the actual interest rate above zero.
Realizing the urgency of the issue, legislators authorized the
State Council to make a decision on the rate of interest tax last
month.
Given all these happenings, it is natural for the public and the
market to expect an interest rate hike and a drop or suspension of
interest tax when the official economic indicators were released
last weekend.
Compared with previous interest hikes, the latest one has been
launched amid public anticipation, which gives it extra strength to
achieve its policy goals.
There had been fierce disputes about the necessity and
effectiveness of interest hikes in recent months. The public doubt
about it directly weakened its power over the economy.
The latest rise also indicates the central bank's incrementing
reliance on the interest rate.
Widely applied as a tool in macro control by central banks
around the world, the interest rate is at the heart of the
financial market, hence a fundamental policy tool in the market
economy.
Although China's market is to be further developed, it is not
hard to see that a flexible and effective scheme of forging prices
for the financial resources is a sign of the maturity of the
financial market.
When the Monetary Policy Committee said it would attach more
importance to the benchmark interest rate and use it as leverage in
financial macro management, it is not hard to see that the central
bank and the committee have had a substantial transformation in
their ideas about the financial market, which will definitely have
a long-reaching bearing on the economic policy of the country.
However, the interest rate hike and the reduction of interest
tax are presented later than they should have been to achieve their
policy goals. The interest rate should also have a bigger increase
than the newly announced figure.
The CPI picked up by percent in a single in June. Before the
interest rate was raised, 3.06 percent was the most interest
achievable from a one-year bank deposit. With tax included, the net
rate of interest was actually minus 1.952 percent.
Once the interest rate is hoisted and the tax reduced, people
will get a net minus 1.2365 percent on a one-year deposit, assuming
the monthly CPI growth stays at 4.4 percent.
Simple mathematics show the latest moves do not help the fact
that the actual interest is less than zero.
Therefore, it is necessary for the central bank to lift the
interest rate by larger margins and more frequently.
Of course, the interest hike and the interest tax cut will
influence the economy in a way that cannot be underestimated.
The two policy moves will change the market expectation because
they will install the impression that the interest rate is a
regular tool at the central bank's avail whenever the economy needs
to be manipulated.
The players must predict the market response to the interest
hike and the countermeasure of the central bank toward this
response before they make their decisions. The policymakers will
also have to look further into the future before changing
policies.
The chain of expectations, speculations and actual revision of
policies and investment decisions from the market and the
authorities will form a pattern of decision-making of strategic
significance to China's financial market and the national
economy.
The two changes also show the central government has established
a new concept of economic management by preferring
market-orientated tools to administrative orders.
It is clear the government is trying to review the pattern of
economic growth in a bid to achieve it in a way that is more
sustainable and friendlier to the public welfare.
The author is a researcher with the Institute of Finance and
Banking under the Chinese Academy of Social Sciences
(China Daily July 25, 2007)
