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The central bank Thursday raised interest rates for the first time in nearly a decade as lingering concerns over inflation and emerging underground loans prompted a bolder move to slow economic growth and lure back money circulating outside the banking system.
After months of debate, the hike of just over a quarter of a percentage point by the People's Bank of China (PBOC) also indicates the central government has finally decided to shift from a selective to a sweeping approach in cooling economic growth, which stood at 9.1 per cent during the first three quarters.
"This interest rate rise... is to make bigger use of economic measures in resource allocation and macro-adjustment," the PBOC said in a statement while announcing the raising of benchmark rates on one-year yuan loans to 5.58 per cent from 5.31 per cent and the rate on one-year deposits to 2.25 per cent from 1.98 per cent.
Before jacking up interest rates, measures used included administrative measures such as banning new investments in certain sectors and imposing tougher rules for converting farmland for industrial use, as well as repeated increases of commercial banks' required reserves.
There have been calls for an interest rate hike from the beginning of the current round of macroeconomic adjustment -- launched in the spring -- but the central government was cautious in this regard fearing that higher funding costs would hurt the sectors that were not overheating.
The initial cooling-down measures did suppress run-away investment growth.
But after a few months, officials and economists found that investment growth remained high and many investors responsible for the undesired growth in sectors such as real estate were obtaining loans from creditors that shun banks because of low interest rates.
Tao Dong, chief China analyst with investment bank Credit Suisse First Boston, estimated that around 120 billion yuan (US$14 billion) is flowing in the non-official system, which is equivalent to 10 per cent of gross domestic product and 0.5 per cent of credit in the banking system.
This is already alarming enough, Tao said.
If this situation deteriorates, it will lead to great financial risks and will be debilitating for banks and the authorities' capabilities in making further adjustments, Tao said.
On the other hand, the consumer price index (CPI), the key indicator for inflation, has been well above 5 per cent. Prices for some materials were reversing the trend and picking up again. Economists believe major prices such as those of oil and grain will also stay at high levels for the rest of the year.
Although the accuracy of the CPI is questioned by some observers, it is agreed its changes could reflect the trend and its sharp upward curve this year means the real interest rate is very close to zero which could spur unhealthy investments.
The last time the PBOC raised lending rates was in July 1995, and rates were last changed in February 2002, when they were lowered to boost a sluggish economy.
In raising interest rates this time, the central bank also gives commercial banks more freedom in setting their own interest rates, a significant move in liberalizing the rates.
The upper limit on the renminbi's lending rates has been scrapped. Banks "in principle" could now charge as much as they want for yuan loans.
Previously, banks could charge no more than 70 per cent over the benchmark rate set by the central bank.
In addition, the banks can now offer a deposit rate lower than the benchmark, a practice that was not allowed before.
The rise was immediately felt across the world, driving price changes in securities, commodity and currency markets amid discussions over the effect of a slowed Chinese economy on the international market.
(China Daily October 29, 2004)
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