China's Blazing Economy Demands Fourth Rate Hike in Five Months

By Jason Simpkins
Staff Writer

Desperate to try and cool off an economy that’s grown at 10% or better for four straight years, China’s central bank raised interest rates yesterday (Tuesday) for the fourth time since March.

China’s CSI 300 Index has climbed approximately 144% this year, after having already doubled in 2006. However, the nation’s rapid economic growth has been accompanied by an accelerating inflation rate, which reached 5.6% in July – a 10-year high.

In response to the mounting risks posed by inflation, the People’s Bank of China has indicated on its website that it will boost rates again. The benchmark one-year lending rate will increase 0.18 percentage points to reach 7.02% today (Wednesday). The one-year deposit rate will rise 0.27 percentage points to reach 3.6%. Also, in an attempt to expel cash from its system, the government announced yesterday that it would now allow individual investors to buy Hong Kong stocks for the first time (See additional details in the Top Stories news column).

In the midst of a global credit crunch, China is one of the only nations trying to eject money from its financial system, but the nation’s current plight requires that action be taken.

Just last week, China lowered the tax on interest income from 20% to 5%. Now, for the second time this year, interest rates paid on deposits have been boosted above lending rates – which suggests China’s government is hoping to lure money away from property and stock speculation, and boost the deposits made in savings accounts. 

People’s Bank of China spokesman Zhang Tao told the official China Securities Journal: “Economic growth is overly fast, and it has been so continuously.” He also pointed out that – in view of the high rate of economic growth in China – the fixed asset-investment, inflation, and money lending may have led China into “a dangerous zone.”

He’s right to be worried. For months, the United States as well as other prominent trade partners has implored the Chinese government to let the Yuan appreciate in value, but to no avail. This refusal has translated into an out-of-control trade deficit, and foreign-currency reserves of $1.33 trillion, a total that’s drawn the ire of many trading partners.

China’s trade surplus reached $24.4 billion in July, its second-highest-monthly total of the year. The nation’s foreign currency reserves reached $1.33 trillion through the first six months of 2007, an increase of nearly 26% from the $1.06 trillion recorded at the end of December. 

The U.S. government recently reported that the United States trade deficit with China jumped 5.7% in June, reaching $21.2 billion – the highest total since January.

There is no question that the United States will surpass the record-setting 2006 trade deficit of $233 billion. 

Money has also been pouring into Chinese assets. According to China’s statistics bureau, fixed-asset investments have also ballooned, reaching $747 billion in the first seven months of this year, a 26.7% increase from a year ago.

For all of 2006, fixed-asset investments advanced 24.5%.

Between January and July of this year, there have been 132,099 new investment projects, 17,168 more than a year ago. Total investment in property development has grown by 28.9% this year, as well.

In addition to spurring inflation, the rapid influx of liquidity has propelled the price of food products, the cost of energy, and wages higher as well. The price of meat has seen a remarkable 50% price increase while food prices in general have climbed 15.4% in July alone. Wages rose 21% in the first quarter of the year over the same period in 2006. And some economists have said that pricing pressures are now growing in the energy sector, where Beijing is holding down retail prices by blocking state-owned gasoline and power companies from passing on higher costs. 

The Yuan has risen 9% against the dollar since it was revalued in July 2005. Higher rates could force the Yuan to appreciate and curtail the flow of cash into China by making exports more costly. China’s initial approach was to implement a gradual drag on the economy, but as investment and inflation continue to shoot skyward, more drastic action may be necessary.