Op-Ed Contributors

Curbing excess domestic liquidity

By Liu Yuhui (China Daily)
Updated: 2010-05-25 07:55

As a result, it has inflated the real estate bubble and the prices of some raw materials have risen faster than the returns from one-year deposits. A hike in interest rates will help change investment activities among enterprises and ordinary investors, affect their expectations for investment returns and help them refrain from some irrational investment decisions.

However, the possibility that China's central bank will raise interest rates by a large margin in a short period is very slim. A gradual increase will inevitably lead to the inflow of more foreign capital into the fledging financial market in the pursuit of high profits.

From January to April, China had increased by 1.1 trillion the renminbi counterpart of its foreign exchange reserves.

The additional amount was largely contributed by cross-border capital flows under strong inflationary expectations other than its trade surplus or foreign direct investment (FDI). The expectation of a renminbi appreciation has stemmed from a fast growing Chinese economy under the effect of a series of stimulus packages.

To curb inflation and the risk of bubbles in some of its sectors, the country should carry out sweeping reforms in its monetary institutions in addition to such measures as a tightened monetary policy, raising its long-term interest rates as well as efforts to contain local governments' unrestrained investment impulse and their expansive fiscal demands.

Under the current economic environment, the central bank will remain particularly cautious about raising interest rates. That is because local governments have incurred heavy debt over the past years as a result of their large-scale investment campaigns.

The local governments' debt level is expected to touch 10 trillion yuan by the end of this year. This means that an increase in the interest rate by one percentage point will increase local governments' annual debt burden by an additional 100 billion yuan.

Domestic banks also hope the current low interest rate regime will last as long as possible so that they have more bullets in stock to fend off any possible outbreak of bad debt.

As the two key players of the Chinese economy, banks and local governments have served as the key factors hindering the country's efforts to raise interest rates.

If the government always values the interests of local governments, banks and some monopolistic departments and only takes measures that help the country's wealth flow from ordinary people to these groups, there is little hope of structural economic transformation.

The author is an economist with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

(China Daily 05/25/2010 page8)