Inflation forces China to raise interest rates twice in two months



China was forced to raise its interest rates for the second time in a little over two months to reign in raging inflation. Higher interest rates in China have attracted heavy foreign capital inflows in recent times from US and Japan because of ultra low interest rate regimes there.

The recent rate hike may indicate that authorities in the world’s second biggest economy are possibly entering into long term monetary tightening policy rater than short term makeshift arrangements such as credit rationing and keeping the local currency undervalued artificially.

In an announcement made on Saturday, the People’s Bank of China said that effective Sunday, one year Yuan deposit rates will be raised to 2.75% from 2.5% and lending rates will go up by 25 basis points (0.25%) to 5.81% from the existing 5.56%. The central bank had last raised the benchmark lending rates by 25 basis points (0.25%) on October 19 after a span of three years.

An Economist with the Royal Bank of Canada – Brian Jackson said this shows that the PBOC may intervene more frequently to suck in excess liquidity and curb inflation if required in 2011. “We expected a rate hike by the end of the year, though Christmas Day is something of a surprise–a rate hike is not normally on the wish-list for Santa Claus, but in China’s case this is a prudent move”, he said.

Arguing the quantitative measures have failed to yield desired results, he said “We think it is increasingly clear that using quantitative measures–such as reserve ratios–to rein in liquidity and credit has not been enough, and that adjusting the price of credit–that is, interest rates–is needed to get price pressures under control, so today’s move suggests Beijing is also coming around to this view”. In 2011, rates may be hiked by 75 basis points (0.75%), he added.

The Deputy Governor of the PBOC Hu Xiaolian had announced on Friday that the central bank will use a host of tools like interest rates and differentiated reserve requirement ratios to curb asset bubble formation. PBOC had raised banks reserve ratios on December 10 by 0.5% (50 basis points), a measure that requires banks to set aside more cash, thus mopping up excess liquidity from the system.

The Consumer Price Index (CPI) rose by 5.1% in November, the fastest in two years in the communist state. Raging inflation has unnerved the politburo as it may slow down economic growth and stoke social unrest in the country.

Liu Mingkang, chairman of the China Banking Regulatory Commission said in Beijing last week “The recent inflation is completely different from the periods of very high inflation China has encountered in the past. Explaining further, he said “There is overcapacity for most industrial goods in the Chinese market and it’s impossible for upstream inflation to be transmitted downstream”.

The benchmark stock index has already slipped by 10% since mid November apprehending the interest rate hike and further monetary tightening policy. In early December, Beijing said it will implement ‘prudent’ economic policies over the ‘moderately loose’ policies in place till now.

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