Analysis: Global market has jitters over China's interest rate increase

17:34, December 27, 2010      

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Is China's interest rate hike, which was announced on Christmas Day, a welcome gift for investors around the world? As the first trading day opens after China's surprise move on Saturday, the global financial market is anxiously watching and speculating about how China's interest rate hike will affect the prices of shares, commodities and gold.

As Reuters said, it is the Chinese stock market that will "set the tone" for the global market. Historical data shows that the Chinese share prices were all up in each of the nine previous interest rate hikes since 2006, a move that is normally supposed to dampen stock markets. There is confidence about the short-term price curve on the market.

However, it seems things are different this time, and the interest rate hike is working on the stock market. The Shanghai Composite Index plummeted by as much as 1.9 percent on Monday afternoon after a slight climb in the morning, reflecting investors' concern over the possibility of more tightening policies in early next year. In spite of that, a survey shows that 95 percent of fund managers are bullish about share prices next year, according to a report by China Securities Journal.

The interest rate increase is regarded as evidence of China's determination to curb its inflation. Although China's CPI hit new records in October and November at 4.4 percent and 5.1 percent, respectively, China has been cautious about using the price tool. It has raised the banks' deposit-reserve ratio six times, but only increased interest rates twice this year. That may mean China's concern over the inflation has outweighed its desire to sustain its rapid economic growth.

The central bank has made it clear that it will use a quantitative measure, namely banks' deposit-reserve ratio, and the credit price, namely the interest rate, as well as foreign exchange rates to get the monetary policy back to "normal."

The Australian dollar dropped against the U.S. dollar Monday as a result of China's interest rate hike because trade with China has a big effect on the Australian economy, according to Reuters. It also predicted that the yuan, China's currency, would gain against the U.S. dollar. On Monday yuan gained ground against the U.S. dollar.

If that is the case in the future, it would be a factor that enables China to shift toward more imports. An aspect that so far has been neglected by analysts observing China's interest rate hike is China's strategy of economic restructuring for a more balanced, innovation-oriented and eco-friendly growth model. Increasing imports is part of the efforts to achieve that. A stronger yuan would of course facilitate China's imports.

In addition, tightened money supply will probably help reign in blind investment, which does not pay enough attention to the quality of investment. In the mean time, sectors facilitating the country's economic restructuring, such as the clean energy and environmental protection, will get more support. In that way, China's economy, which is currently investment driven, will grow in a slower but more rational way.

China's interest rate hike has happened while the interest rate in the United States remains low. That has fueled the concern over the risk of hot money flooding into China. Analysts are divided on that prospect. But Chinese banks reported huge forex dealing surplus in November. And the Ministry of Commerce has recently beefed up surveillance over the surging foreign investment into China's property market. The market should wait and see whether more capital control measures would be installed.

International institutions seem to have reached a consensus on gold prices. Financial giants, such as Goldman Sachs, Barclays and JP Morgan Chase all predict a golden age for gold prices in 2011 as long as the interest rates in the United States are kept low and emerging markets continue buying gold.

China Securities Journal reported on Dec. 25, the day when the People's Bank of China announced the interest rate hike, that Xia Bin, an advisor of the People's Bank of China, said that China should hold more gold reserves to diversify its forex reserve.

By Li Jia, People’s Daily Online
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