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March 18, 2007
Inflation Chickens Roosting In China?
The People's Bank of China, the central bank, raised key savings and lending interest rates from Sunday, March 18, the third time in 11 months in a bid to curb inflation and asset bubbles in the world's fastest-growing major economy.
The one-year benchmark lending rate will be raised to 6.39 percent from 6.12 percent, and the one-year deposit rate will be increased to 2.79 percent from 2.52 percent, according to a statement on the bank's website (www.pbc.gov.cn) .
Time to start up the yuan appreciation clock? From the Wall Street Journal:
After Saturday's credit tightening, [Goldman Sachs Group Inc. economist Hong Liang] said, she expects authorities in China to continue efforts to pull liquidity from the financial system with technical measures, possibly another interest rate increase and steady appreciation of its currency against the U.S. dollar...
Many economists regard China's tight grip on the value of its yuan as an underlying reason for Beijing's concern about financial system stability. A weak currency helps keep exports cheap and China's strong export growth has pumped U.S. dollars into the country, as evidenced by foreign exchange reserves that top $1 trillion. When that money is moved into yuan, banks are left flush with funds to lend out. Too much lending risks sparking inflation or leaving banks holding bad loans.
The Chinese government, however, continues to suggest that we should not expect too much too fast. From the Financial Times:
China on Friday sought to reassure global currency markets that a new state investment agency set up to chase higher returns for its $1,000bn-plus in foreign exchanges reserves would not harm the value of the US dollar.
Wen Jiabao, premier, said at a press conference to close the National People’s Congress that investments by the agency “would not have any impact on US dollar-denominated assets”.
Mr Wen’s comments were reinforced by the People’s Bank of China, the central Bank, which said in a report issued hours later that it would not make “frequent, major adjustments to the structure of the reserves in response to market movements”...
Mr Wen’s reassurance on the US dollar is also in China’s self-interest, since any dollar sell-off would leave huge capital losses for Beijing’s existing holdings.
Are an unadjusted yuan, still-strict capital controls, and low inflation compatible goals? Normally one would would think not, but we shouldn't forget this (again from the Wall Street Journal):
China only reluctantly adjusts base interest rates. Analysts say that reflects how interest rates have less impact on lending and borrowing decisions in China than they do in countries with more highly developed financial systems. Instead, to temper lending and the economy, China's central bank more often relies on moral suasion with state-controlled banks and technical adjustments to capital requirements.
So, the answer is probably "Sure, if the government is willing to institute even tighter controls on the allocation of financial resources." I doubt, however, that many would be inclined to advise taking that path.
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