Chinese rate hike aims at cooling down the economy

China's economic growth is continuing unabated. In 2009 and 2010, the annual growth rate remained at about 10 percent. But Gu Xuewu, a political scientist at Bonn University, says this growth is not yet self-sustaining. "The growth we have seen in China for the past two years can be ascribed to massive investment by the state." The central government in Beijing has propped up the domestic economy with a stimulus of 460 billion euros.

At the same time, the banks handed out loans generously: in 2009, they lent a record 10 billion yuan (one billion euros) to customers. Looking for the highest profit, investors have increasingly invested in real estate, which has pushed up housing prices. This year, the government has tried on several occasions to counter overheating tendencies in the real estate market. The central bank raised the minimum reserve ratio six times. At present, the commercial banks must hold an unprecedented 19 percent of their deposits. With this requirement, the central bank is trying to tighten liquidity.

Inflation worries

In October, the benchmark interest rate was raised for the first time since 2007. This is not only aimed at reducing the availability of credit but, more importantly, at dampening inflation. In November, the inflation rate rose above five percent for the first time in two years. Food prices even rose by more than ten percent. This affects the general public and could easily cause trouble. By raising the benchmark interest rate by another 25 basis points to 5.81 percent, the Chinese governments hopes to come to grips with this problem.

But Gu Xuewu doubts whether raising the interest rate is going to help "because inflation is basically imported. The prices for items such as raw materials, energy and grain - where China is highly dependent on the international markets - have gone up dramatically over the past weeks, with the Americans pumping another 600 billion dollars into the economy."

The lax monetary policy of the US Federal Reserve has not only driven up global energy prices, the American money is also constantly searching for lucrative investment, and a part of it is ending up, hardly surprising, in China. "Money will always move to the place that has higher interest rates," says Gu. "And at present, this definitely is China, where you have interest rates of between five and six percent, compared to 0.25 percent in the United States."

More pressure to raise the value of the yuan

The recent interest rate hike is going to attract even more foreign money to China, Gu believes. And that will in turn increase the pressure for a higher value of the Chinese currency, the yuan, also known as renminbi.

The calls for a substantial revaluation of the yuan have grown louder after the November import and export figures were announced. Last month, the People's Republic exported products worth 150 billion US dollars and spent 130 billion dollars for imported goods, both record figures. Making the yuan more expensive would also help the government in fighting inflation. But Beijing continues to aim for a gradual appreciation, not an abrupt one. Rightly so, argues Jens Ruebbert, who works for Deutsche Bank in Beijing. "Of course this is a balancing act between the need for currency revaluation and for protecting the domestic economy, in particular the exports. It is a tightrope walk. But I think the Chinese should give more importance to protect jobs."

Whether China will be able to keep this balance and maintain its robust growth even without stimulus packages, will mainly depend on how successful it will be in shifting its export-based growth model to an economy also supported by strong domestic demand.

Author: Danhong Zhang (tb)
Editor: Sarah Berning