China raising interest rates in bid to cool inflation

China raising interest rates in bid to cool inflation
By David Lague
Copyright by THe International Herald Tribune
Published: August 21, 2007


BEIJING: China announced Tuesday that it would raise interest rates for a fourth time this year in an effort to contain its racing economy and rein in soaring consumer prices.

The People's Bank of China, the central bank, said on its Web site that the benchmark one-year lending rate would rise 18 basis points to 7.02 percent as of Wednesday, and the rate for deposits would rise 27 basis points to 3.6 percent.

Analysts said that the rate increase was also aimed at cooling the Chinese stock market which has so far escaped the turmoil that the U.S. subprime mortgage crisis has unleashed on global financial markets.

In the aftermath of the U.S. Federal Reserve's move Friday to cut its discount rate to steady financial markets, China's decision demonstrates how the world's fastest growing major economy sometimes appears to be insulated from global economic forces.

"China is now counteracting the U.S. cycle," said Connie Leung, chief economist at ERA Economic Research Analysis, a research and advisory business in Hong Kong. "China is one of the few markets in the world to be raising rates rather than holding or cutting rates."

The ruling Communist Party fears that rising prices fueled by an overheated economy could hurt millions of poor Chinese, particularly in rural areas where economic hardship or dissatisfaction with the government can often lead to protests and unrest.

But the authorities must avoid too sharp a slowdown because rapid economic growth is needed to provide jobs for millions of surplus rural workers.

Leung and other analysts expect China to raise rates further before the end of the year, perhaps more than once, as part of a sustained campaign to bring growth under control.

In addition to raising rates, the central bank, six times this year, has ordered lenders to increase the amount of funds they must hold in reserve in an effort to tighten the supply of credit.

Many economists had expected China to raise rates further after official statistics showed that inflation jumped to 5.6 percent in July, the biggest monthly increase since 1997, mainly due to steep increases in the cost of food including pork and other household goods.

The official target for inflation for 2007 is 3 percent. The Chinese economy expanded at 11.9 percent in the second quarter compared to the same period last year, the fastest growth in more than 12 years as exports and investment continue to boom.

In July, China's trade surplus jumped 67 percent from a year earlier to $24 billion. Fixed asset investment in urban China increased 26.6 percent during the first seven months of the year.

But, China's top economic planning agency and price monitor, the National Development and Reform Commission, said the country was not in danger of entering a period of "full-scale" inflation, the official China Daily newspaper reported Tuesday.

The paper reported that the NDRC had analyzed rising prices and found that they were limited to a narrow ranger of consumer goods.

With limited options for investment outside bank deposits, millions of Chinese savers have turned to the stock market in recent years, driving a surge in share prices that has seen the benchmark Shanghai Composite Index rise 80 percent this year following a 130 percent increase last year.

The flow of savings to the stock market has accelerated as inflation outpaced interest paid on deposits.