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Home » Opinion » Chinese Views
Balancing choices for economy
By Sun Lijian |
May 13, 2010, Thursday
|
Print Edition
Print Edition
THE announcement of the People's Bank of China on May 2 to raise commercial banks' reserve requirement ratio went into effect Monday.
The ratio rose for the third time this year, by 0.5 percentage point. This increase is aimed at limiting the share of deposits that banks can lend, thereby draining excess liquidity in the market.
Because the ratio increase came amid ongoing government efforts to keep China's overheated housing prices in check, it has been interpreted by pundits as a prelude to Beijing's move to raise interest rates and eventually junk its loose monetary policy.
Indeed, the Chinese government now faces a double whammy. The soaring prices of bulk stock worldwide have exerted upward pressure on commodity prices in China.
Meanwhile, the country's real estate sector poses a systemic risk as it diverts money from the real economy into the housing sector, further inflating its bubbles.
The reason why China refrained from raising interest rates - a move that many believe could tighten money supply and forestall inflation - is, in my opinion, threefold.
First, the Chinese economy may appear strong, but it's actually much less so if we look at the country's real economy, which still lacks a healthy model for sustained prosperity. Unless the real economy recovers some of its lost vitality, any overdose of monetary austerity, like a sweeping interest rate change, would do no more than channel excess liquidity from the real estate sector into the stock market or other financial services.
As such, intensified monetary rigor could do little to stamp out the root cause of asset bubbles. In this sense, the PBOC's decision to raise the reserve requirement ratio might have the effect of restricting the biggest amount of money possible that goes into the housing sector, while having a minimal impact on the real economy's recovery.
Possible jitters
Second, an interest rate hike is no longer only a matter of monetary policy. Countries implementing hikes are seen to be sending a clear signal that government intervention in the market is on its way out.
But if a country's economy remains sluggish, an early scale-down of government stimulus will likely send jitters through the market, dragging down investment and consumption.
It will also wipe out gains brought about by a proactive fiscal policy and a moderately loose monetary policy.
Nobody can guarantee that without government bailout the global economy could still maintain its full momentum.
In the event of an abrupt interest rate increase in China, hot money and "footloose" money - money that naturally gravitates to industries with higher profit margins - would engage in short-term speculative transactions. This scenario would heighten the pressure on the yuan to rise and disrupt the recovery of China's real economy.
Third, the expiration of 3-year central bank bills, issued by the PBOC as another measure to rein in loose credit, will release some liquidity back into the market.
As China's commodity prices continue their upswing, the government will have to seriously address the possibility of superfluous capital moving in the market.
The economic well-being of Western countries contrasts sharply with that of China and a handful of Asian nations.
In the US and Europe, where excess capacity and unemployment rates are still high, deflation is their major concern. Added to their credit crunch blues is the recent Greek debt crisis and hangover from the Wall Street debacle.
The same cannot be said of East Asian countries like South Korea, Thailand and Indonesia, which have experienced significant inflation but have yet to announce interest rate rises.
Moreover, signs abound that global fluid capital has flowed into these countries' property markets and created bubbles. Hence, China's recent adjustment of the reserve requirement ratio is a difficult choice of "the lesser of two evils." What's more, battling inflation and pricking asset bubbles in an open economic environment will probably top the economic agendas of Asian governments from now on.
To sum up, the timing of China's interest rate hike is tied to following factors: inflation risks, effects of monetary austerity, China's market robustness, the yuan's appreciation, speculative pressure from a gap between Chinese and foreign interest rates and a global stimulus exit plan.
Whatever the outside expectation, China should stick to liquidity-tightening measures such as strengthening capital management, issuing central bank bills and bolstering commercial banks' capital sufficiency.
To squeeze the room for profiteering on interest rates, China may do well to speed the yuan's appreciation at some point. And only when the restructuring of its economic system is finished will the time be ripe for the country to raise interest rates and withdraw support for the stimulus plan - preferably done in sync with leading developed countries to mitigate costs and risks of a unilateral stimulus scale-down.
However, there is a likelihood that inflation and asset bubbles may indeed spin out of control in the third or fourth quarter of this year.
If this becomes reality, then the PBOC will be totally justified in lifting interest rates and letting the yuan appreciate to avert a hard landing of the economy.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University. Shanghai Daily staff writer Ni Tao translated and edited his article originally written in Chinese.)
The ratio rose for the third time this year, by 0.5 percentage point. This increase is aimed at limiting the share of deposits that banks can lend, thereby draining excess liquidity in the market.
Because the ratio increase came amid ongoing government efforts to keep China's overheated housing prices in check, it has been interpreted by pundits as a prelude to Beijing's move to raise interest rates and eventually junk its loose monetary policy.
Indeed, the Chinese government now faces a double whammy. The soaring prices of bulk stock worldwide have exerted upward pressure on commodity prices in China.
Meanwhile, the country's real estate sector poses a systemic risk as it diverts money from the real economy into the housing sector, further inflating its bubbles.
The reason why China refrained from raising interest rates - a move that many believe could tighten money supply and forestall inflation - is, in my opinion, threefold.
First, the Chinese economy may appear strong, but it's actually much less so if we look at the country's real economy, which still lacks a healthy model for sustained prosperity. Unless the real economy recovers some of its lost vitality, any overdose of monetary austerity, like a sweeping interest rate change, would do no more than channel excess liquidity from the real estate sector into the stock market or other financial services.
As such, intensified monetary rigor could do little to stamp out the root cause of asset bubbles. In this sense, the PBOC's decision to raise the reserve requirement ratio might have the effect of restricting the biggest amount of money possible that goes into the housing sector, while having a minimal impact on the real economy's recovery.
Possible jitters
Second, an interest rate hike is no longer only a matter of monetary policy. Countries implementing hikes are seen to be sending a clear signal that government intervention in the market is on its way out.
But if a country's economy remains sluggish, an early scale-down of government stimulus will likely send jitters through the market, dragging down investment and consumption.
It will also wipe out gains brought about by a proactive fiscal policy and a moderately loose monetary policy.
Nobody can guarantee that without government bailout the global economy could still maintain its full momentum.
In the event of an abrupt interest rate increase in China, hot money and "footloose" money - money that naturally gravitates to industries with higher profit margins - would engage in short-term speculative transactions. This scenario would heighten the pressure on the yuan to rise and disrupt the recovery of China's real economy.
Third, the expiration of 3-year central bank bills, issued by the PBOC as another measure to rein in loose credit, will release some liquidity back into the market.
As China's commodity prices continue their upswing, the government will have to seriously address the possibility of superfluous capital moving in the market.
The economic well-being of Western countries contrasts sharply with that of China and a handful of Asian nations.
In the US and Europe, where excess capacity and unemployment rates are still high, deflation is their major concern. Added to their credit crunch blues is the recent Greek debt crisis and hangover from the Wall Street debacle.
The same cannot be said of East Asian countries like South Korea, Thailand and Indonesia, which have experienced significant inflation but have yet to announce interest rate rises.
Moreover, signs abound that global fluid capital has flowed into these countries' property markets and created bubbles. Hence, China's recent adjustment of the reserve requirement ratio is a difficult choice of "the lesser of two evils." What's more, battling inflation and pricking asset bubbles in an open economic environment will probably top the economic agendas of Asian governments from now on.
To sum up, the timing of China's interest rate hike is tied to following factors: inflation risks, effects of monetary austerity, China's market robustness, the yuan's appreciation, speculative pressure from a gap between Chinese and foreign interest rates and a global stimulus exit plan.
Whatever the outside expectation, China should stick to liquidity-tightening measures such as strengthening capital management, issuing central bank bills and bolstering commercial banks' capital sufficiency.
To squeeze the room for profiteering on interest rates, China may do well to speed the yuan's appreciation at some point. And only when the restructuring of its economic system is finished will the time be ripe for the country to raise interest rates and withdraw support for the stimulus plan - preferably done in sync with leading developed countries to mitigate costs and risks of a unilateral stimulus scale-down.
However, there is a likelihood that inflation and asset bubbles may indeed spin out of control in the third or fourth quarter of this year.
If this becomes reality, then the PBOC will be totally justified in lifting interest rates and letting the yuan appreciate to avert a hard landing of the economy.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University. Shanghai Daily staff writer Ni Tao translated and edited his article originally written in Chinese.)
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