China's Explosive GDP Growth May Force Government to Raise Yuan and Interest Rates

China's economy raced ahead in the first quarter at the fastest pace in almost three years, underscoring concerns about overheating and prompting speculation that the government will be forced to raise interest rates in addition to scrapping the yuan's peg to the dollar.

China's gross domestic product (GDP) rang up unexpectedly strong annual growth of 11.9%, the fastest pace since 2007 and above the median forecast of 11.5% projected in a Reuters poll of economists. 

The GDP figure was aided by a low base of comparison from a year earlier when the economy was hampered by the global financial meltdown, but most economists said the figures were evidence of the need for a firmer stance on both borrowing rates and currency policy.

"Yuan stability and China's stimulus package made an enormous contribution to global stability in the aftermath of the crisis, but now that China's economy is growing by 12%, it's time for China to share some of that growth with the rest of the world via appreciating its exchange rate," Glenn Maguire, an analyst with Societe Generale SA (OTC: SCGLY) in Hong Kong, told Reuters.

Beijing responded by reiterating its opposition to a stronger yuan. A Commerce Ministry spokesman said U.S. officials are incorrect in arguing that maintaining the two-year old peg to the dollar is giving Chinese exporters an unfair competitive edge, Reuters reported.

The yuan, also known as the renminbi, rose modestly in the offshore forwards market, which was pricing in a 3.3% rise against the dollar over the next year, Bloomberg News reported.

Concern Over Property Price Bubble

The government is keeping an especially keen eye on a potential bubble in the real estate market. Property prices in China in March grew at the fastest pace in nearly five years, according to official figures released Wednesday.

Prices nationwide leapt 11.7% in the first quarter, but some popular markets exhibited explosive growth rates.

In the southern island province of Hainan, a popular tourist destination, prices in the provincial capital Haikou rose an average 64.8% from a year earlier, while those in the resort city of Sanya jumped 57.5%. Prices in Guangzhou, the capital of the southern province of Guangdong, rose 20.3%, The Wall Street Journal reported.

After the GDP announcement and the report on the surge in property prices, the government announced measures to cool the real-estate market, raising mortgage rates and down payment requirements for investment properties. Buyers must now come up with 50% of the cost of a second home, up from 40%.
The government also is studying raising taxes on real estate sales, including individuals' profits.

"This will have an immediate impact on speculative house buyers," Huang Qinglin, a property analyst with Great Wall Securities in Shenzhen told Reuters.
But the measures aren't enough to control a real estate bubble that could rattle economies around the world if it bursts, Brian Jackson, a Hong Kong-based strategist at Royal Bank of Canada (NYSE: RY), told Bloomberg.

"The case for policy tightening remains intact given the risks of China's economy overheating," he said. "The additional measures announced today suggest policy makers remain reluctant to use the blunt instrument of higher interest rates, but it is unlikely that extra fine-tuning will be enough to slow down the property market."

Despite rocketing real estate prices, increases in the broader consumer price index have been relatively tame, rising only 2.4% in March from a year earlier.  That puts inflation below Beijing's 3% target, so additional measures may yet be needed to keep price rises in an acceptable range. 

Instead of raising rates, China has twice asked banks to increase reserve requirements in an effort to reduce lending from 2009 levels - when banks loosened credit to support the government's $584 billion (4 trillion yuan) stimulus spending package.  The aim is to reduce bank lending by 22% from the $1.4 trillion (9.6 trillion yuan) banks lent last year to $1.1 trillion (7.5 trillion yuan) this year.

After the government set the lower lending targets, lending dropped significantly in February and March of this year. Fixed-asset investment in urban areas, an important measure of capital spending, has also been slowing from over 30% growth last year to 26.4% in the first quarter, The Journal reported.

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