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Interest rate hike a plus, but more should follow
2006-08-23
China Daily
The People's Bank of China has decided to revise upward the bank interest rate, effective August 19.
The interest on one-year bank deposits, for example, has been upped by 0.27 percentage points, from 2.25 per cent to 2.52 per cent. At the same time, the interest rate for one-year loans is also up by 0.27 percentage points, from 5.85 per cent to 6.12 per cent. The interest rates of long-term savings and loans are pushed up by larger margins.
The interest-rate hike is aimed at braking the runaway investment in fixed assets and slowing down the pace at which bank loans expand. All this, in turn, is expected to bring down soaring real estate prices. Ultimately, the measures are hoped to lead investment and bank loans into a reasonable channel, offer guidance to enterprises and bank institutions in terms of their expectations for returns from their investment and get the volatility seen in the domestic financial market under control.
Though a bit late, the current rate increases are still welcome, as they are among the best instruments for co-ordinating and regulating the economy on a macro basis.
Superficially, the country's financial landscape seems to be marked by excessive fixed-asset investment, over-expansion of bank loans, the abnormally fast-increasing trade surplus and high consumption of energy resources. All this finds expression in high-degree volatility in the domestic financial market.
In view of these phenomena, the central bank tried to bring down the degree of this kind of volatility via directive-command methods. But the central bank has now realized that the root cause of the volatility lies in the low interest rates. Only with interest-rate hikes as the departure point can the overheating fixed-asset investment and runaway bank loans be effectively controlled.
The world's mature market economies also have macroeconomic problems. But all their central banks have to do is apply the leverage of interest rates. The Federal Reserve of the United States, for example, has introduced 17 interest-rate increases since June 2004 in its macroeconomic co-ordination and regulation.
The Chinese central bank, too, started to increase the interest rate at roughly the same time. But there have been only one and a half interest hikes. The "half" refers to the fact that the interest rate of one-year bank loans was raised while that of one-year bank deposits remained the same. How could we expect that kind of "fine tuning" to have any impact on the domestic financial market?
In the context of financial globalization, which makes the world's countries increasingly closely associated with each other, the central banks in all nations, developed and developing alike, co-ordinate and regulate their economies by raising or lowering interest rates. Their common efforts in this regard have combined to put in place a channel through which interest rates in the global financial market keep rising. We have seen, for instance, interest-rate hikes in Britain, the euro-zone countries, Japan and the Republic of Korea.
By contrast, the Chinese central bank opted instead for command methods, largely ignoring the interest-rate leverage. This may explain why macro-regulation in the country has failed to achieve desirable results so far.
In the scenario of low interest rates, allocation of monetary resources cannot help but be of low efficiency. This is because the lower the capital's price is, the less efficient monetary resources allocation becomes. When the interest rate is zero, the return from the capital is also nil.
Furthermore, in a unified monetary market, price leverage is the most effective instrument in dictating the behaviour and conduct of enterprises and individuals. In other words, this is the way in which the local governments and other non-market actors have the least sway.
The exclusively command methods, while having widely varying impacts on the market, open the door wide for interference from non-market actors and, in turn, seriously prevents macroeconomic co-ordination and regulation from working effectively.
This time, the interest-rate rise is marked by some attributes.
To begin with, the longer the period of deposits or loans is, the larger the margin of increase becomes. The interest rate for current deposits remains unchanged, for example, whilst that for five-year savings goes up by the largest margin.
This indicates that the central bank hopes to put a brake on the demand for long-term loans and lengthen the period of people's deposits in the banks.
Second, the hike is designed to make the interest rate of housing loans borrowed by individuals more market-orientated in order to lessen the financial burden on the ordinary housing buyers.
Overall, the central bank's interest-rate increase scheme is quite necessary, if a little late in coming. It is hoped that the People's Bank will closely watch over the market response to the interest-rate increase measures and, accordingly, decide the frequency of interest-rate hikes in the future.
The situation where a very long interval set in after the 2004 rate increase should be avoided. This author hopes the central bank will continuously increase the interest rate according to the reality of the market, because this is the best leverage in co-ordinating and regulating the economy on the macro basis.
The author is a researcher from the Institute of Finance and Banking under the Chinese Academy of Social Sciences.
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