China may raise rates if inflation exceeds 5%
(Bloomberg)
Updated: 2004-05-18 10:13

"If consumer prices become uncontrollable, that is rising above the bearable limit of 5 percent, China may have to raise interest rates," Li Yang, a member of the central bank's monetary policy committee, said Monday after a conference organized by CLSA Ltd. in the eastern port city of Qingdao.

The central bank is concerned that an inflation rate higher than the one-year lending rate, currently 5.31 percent, may exacerbate price rises by encouraging companies to borrow and stockpile materials for profit. China's inflation accelerated to a seven-year high of 3.8 percent last month.

The central bank is trying to curb money supply and credit growth to help cool spending in industries such as steel, cement and real estate. China's investment in factories, roads and other fixed assets jumped 43 percent in the first quarter.

The inflation rate may approach 5 percent in the three months starting in May because of last year's SARS epidemic, which depressed prices in the comparable months, central bank Vice Governor Wu Xiaoling said in an April 27 interview.

Money Supply

China is unlikely to raise interest rates in the next six months unless inflation accelerates further because an increase won't necessarily help to curb money supply, said Li, who's also director general of the Institute of Finance & Banking, a think- tank under the Chinese Academy of Social Sciences.

M2, China's broadest measure of money supply, grew 19 percent from a year earlier in April, exceeding the central bank's target for a 16th straight month, the bank said May 13.

"Unlike developed countries like the U.S., a rise in interest rates doesn't mean the money in circulation will drop,'' he said. "In China there isn't a close relation between interest rates and money supply."

The government is also reluctant to raise interest rates out of concern that a wider gap between yuan and dollar deposit rates would attract further overseas capital inflows, Li said. The one-year yuan deposit rate is 1.98 percent, against 0.95625 percent for a one-year dollar deposit in China. The one-year deposit rate in the U.S. is 1.06 percent.

Capital inflows help to fuel money supply growth because the central bank has to exchange dollars for yuan to support the Chinese currency's peg to the U.S. currency. China's foreign-exchange reserves, the world's second biggest after Japan's, rose to a record US$439.8 billion at the end of March.

China will wait for the U.S. to raise interest rates before doing the same because an earlier move would put pressure on the fixed currency link, Hong Kong Financial Secretary Henry Tang said in an interview on Monday.

The central bank's benchmark one-year lending rate was last raised in July 1995. The bank said last week it will keep monetary policy "appropriately tight."

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