Interest rate hikes to contain inflation, help finance small biz

15:42, July 09, 2011      

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The People's Bank of China has raised interest rates by 25 basis points on Thursday, making one-year deposit rates go up to 3.5 percent, while one-year lending rates increase to 6.56 percent.

Raising the interest rates is conducive to managing inflation expectations, correcting the state of negative interest rates and easing the financing difficulties for small and medium-sized enterprises, said financial policy officials.

"As the market widely predicted that China's CPI will hit a record high in June, raising the interest rates is conducive to managing inflation expectations and signifies that curbing inflation is still the primary target of the current macroeconomic policy," said Ba Shusong, deputy director of the Institute of Finance and Banking under the Development Research Center of the State Council and chief economist of the China Banking Association.

Raising the interest rates is conducive to correcting the state of negative interest rates. China's economy entered a sustained state of negative interest rates along with the rising CPI since February 2010. Household savings have withdrawn from the banking system because it is difficult for household savings to keep value and rise in value. This has further increased inflationary pressures.

Raising the interest rates is conducive to narrowing the gap between the official interest rates and the market interest rates. The People's Bank of China previously used more quantitative tools, such as the deposit-reserve ratio, to regulate and control the market. Because tightening the amount of capital promoted a rise in the cost of capital, raising interest rates is also the requirement to follow the interest rate trend on the market.

Raising the interest rates is also conducive to easing the financing difficulties for small and medium-sized enterprises. "Raising the interest rates can curb the financial needs of large-scale enterprises, and squeeze part of the credit to expand supply for small and medium-sized and enterprises to reduce their pressures on financing," Ba said, "In this sense, raising the interest rates is more conducive to small and medium-sized enterprises while raising the deposit reserve ratio is more conducive to large-scale enterprises."

The central bank chose to raise the interest rates now that it can clearly see the situation, indicating that it is cautious in attitude, and inflationary pressure will remain high in June and July.

Why did the central bank take no action in June when the market had strong expectations of interest rate hikes, but decidedly raised the interest rates in July?

The price situation for June and July has generally become clear. The off-season rise in pork prices has become a major force pushing up the CPI; a dramatic shift from drought to flood in the south and reduced vegetable output have stabilized the downward trend for vegetable prices; and the carryover effect will raise the CPI for June by about 4 percentage points, the highest in 2011. These factors will cause the CPI for June to set a new high.

"It is expected that the CPI will exceed 6 percent for June and remain at the high level of around 6 percent for June, driven by the upward trend of domestic pork prices despite the drop in international commodity prices," Ba said.

Experts said that the year-on-year GDP growth rate from the first quarter of 2010 to the first quarter of 2011 stood at 11.9 percent, 10.3 percent, 9.6 percent, 9.8 percent and 9.7 percent respectively, showing a moderate downward trend. That the central bank did not raise the interest rates until it was aware of the price situation shows that the central bank has properly handled the relationship between maintaining stable and relatively economic growth and adjusting the economic structure as well as managing inflationary expectations, and has adopted a prudent attitude to use price-related monetary instruments. The interest rate hike before the release of the CPI data for July also implies that the inflationary pressure will remain at a high level in June and July.

Ba said that the CPI will remain at a high level for some time after falling back from a peak in the second half and remain above 5 percent in the third quarter.

"To cope with a negative interest rate and consolidate the effects of anti-inflation efforts, the central bank will likely raise the interest rates one or two times in the future," Ba said.

Interest rate hike likely to bolster stock market rally

"Because the central bank finally increased interest rates again, the stock market may resume its rally," said a Beijing-based private investor surnamed Wang, who was glad to hear the news about the interest rate hike. He believes that improved market liquidity was a leading factor behind the stock market rally that started in late June.

However, as inter-bank lending rates rose sharply on July 5, the market expectations for a rise in interest rates soared immediately, and the stock market rally suspended accordingly. After learning that the central bank did raise interest rates again, investors must feel relieved, and the market rally may resume and last longer.

The central bank has raised interest rates several times since last year. There were mixed upward and downward trends in the stock market in the short to medium term almost every time after the increases in interest rates. It seems that the changes in interest rates did not produce any noticeable effects on the stock market.

Market analysts said that all kinds of information released since the beginning of June showed that the stock market pessimism has dissipated, and investor confidence has returned. After a comprehensive look at various factors, the conclusion can be drawn that the domestic stock market, which stayed in a period of low tide in the past few months, will soon resume its rally.

Liu Xianjun, chief strategy analyst at China Securities Company, said that interest rate increases do not matter much. What really affect the short- to mid-term trends of the stock market are people's expectations about whether the central bank will continue to raise interest rates this year.

The current domestic economic situation is that some industries and companies suffer fund shortages, while other industries and companies enjoy abundant capital. Therefore, China's monetary policy is likely to undergo only some minor fine-tuning rather than a major change for some time to come. However, many investors expect the monetary policy to undergo a major change. They should consider more to make more reasonable expectations.

Pessimistic investors believe that the current circumstance does not possess the foundation for getting out of the persistent trend. In the second half of 2011, it is possible that the CPI will drop from the high position, but it will still fluctuate at a certain high level. The situation of negative interest rate will continue, and the pressure on stock markets will not be fundamentally turned around. The factors that led to the decline of stock markets have not been fully eliminated, and therefore investors should not be too optimistic about the future trend of stock markets.

Interest rate rise will suppress demand for housing purchasing and the housing price will have a decreasing trend.

After the interest rate was raised, the base interest rate of above five-year terms has exceeded the historical high psychological level of 7 percent. Insiders believe that while the real estate market is going down, the interest rate rising of this round will have more obvious effects on the real estate market, and especially will further restrain the rigid demand for housing purchasing.

Zhang Dawei, a market analyst from Central Group, believes that the increased pressure from repaying the loans will further restrain the irrational purchasers with rigid demand for housing. For housing purchasers with tight budgets, renting a house is a more rational choice temporarily.

Regarding the current real estate market, where transactions are rare and the housing price is loosening, the combination of raising interest rate and launching adjustment and control policies will further show its strong power. Under the condition of strict housing-purchasing limitations, the major reason for some people to still purchase housing is the inflation and sufficient currency supply, and that they do not have better channels to invest in. The investigation on depositors carried out by the Central Bank in the second quarter of 2011 showed that the residents who chose real estate as their investment direction accounted for 22.2 percent, meaning that the real estate is still a major choice for residents to invest in. The interest rate hike will obviously increase the cost of investments and make it more difficult to get loans, and therefore will restrain investment demand.

In general, raising the interest rate will have more obvious effects on restraining the demand for housing purchasing, and in the current declining real estate market, housing prices will show a more obvious decreasing trend.

By People's Daily Online
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