China: Tasked with putting its house in order

15:26, March 01, 2010      

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Central government also faces a dilemma in deciding on its interest rate policies.

As inflation rises - it was 1.9 percent in December and 1.5 percent in January - the market has expected an interest rate hike to come sooner or later.

While the real interest rate risks falling into negative territory due to rising inflation, any hasty adjustment of it could hurt enterprises, especially job-creating private companies, and could even shake the newly recovered economy. It could also stoke inflows of speculative capital from overseas.

"While we expect the central bank to deliver 81 base points of rate hikes this year to avoid real rates turning negative, we do not expect aggressive credit tightening to last long," said Nomura Securities economist Sun Mingchun in a recent report.

Most economists forecast that inflation could reach 3 percent in February, when consumption was active thanks to the traditional Spring Festival, which started Feb 14. And they said there was a possibility of inflation rising further in the coming months, partly due to the relatively low base a year ago.

"If inflation rises fast and GDP growth remains solid (so that an interest rate hike would not hurt it too much), it is more likely that the central bank would raise the rate," said Lian Ping, chief economist of the Bank of Communications.

But interest rate hikes are not the only tools that the authorities could use to tighten the economy, analysts said.

"The authorities can also resort to 'window guidance', or 'moral suasion' (direct order), to curb lending growth and liquidity-incurred inflation," said Lian.

Any hike would come only when the economic growth trends become clear after the release first-quarter data, said Zhang Xiaojing. Therefore, it is more likely to come in the second quarter, if the US Federal Reserve does not raise interest rates unexpectedly, he said.

Yuan appreciation

Thanks to the strong rebound in exports in the past two months and China's ever-expanding foreign exchange reserves, the nation is facing unprecedented pressure to revalue the yuan, although its value has risen by more than 20 percent since the currency system was reformed five years ago.

China's foreign exchange reserves amounted to $2.4 trillion by the end of 2009. The trade frictions between the US and China have also led to mounting pressure for yuan appreciation.

Premier Wen Jiabao has vowed that the yuan's exchange rate is a matter for China's sovereign decision and said he would not bow to outside pressure. But analysts said the country could allow the yuan to be more flexible this year.

"Outside pressure should not be the factor pushing us to reform, but yuan appreciation will help us restructure our economy, helping it to become more high-tech-oriented and energy-efficient," said Zhang.

Revaluing the yuan could also be part of the fiscal stimulus exit strategy because it would increase the cost of exports. However, it would not help narrow the China-US trade gap, analysts said.

James Riedel, William L. Clayton Professor of International Economics at Johns Hopkins University, pointed out that the US trade deficit with China in essence has little to do with the yuan's value. "China will always have a surplus with the US, as do most Asian countries," he said. The US's overall deficit is in effect due to the various factors that influence the level of expenditure relative to income in the US.

"The US deficit is due to the fact that the US spends more than it earns. When you spend more than you earn, you naturally go into debt," said Riedel.

Source: China Daily
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