China has resumed hiking interest rates after a three-month hiatus, stoking market fears of a slowdown in the country's economy, whose rapid expansion has been a cornerstone of the global recovery.
The People's Bank of China is boosting its benchmark one-year deposit and lending rates by 0.25 per cent – to 3.5 per cent and 6.56 per cent, respectively. It's the latest in a series of modest moves aimed at cooling off overheated asset prices and reining in rising consumer prices. The fifth rate hike in the past nine months was telegraphed in advance by the central bank, which is still seeking to dampen inflation expectations without taking more drastic action on the monetary front that could bring the economy crashing down.
Such a "hard landing" would reverberate around the world, putting at grave risk an already stumbling global recovery. Even a soft landing, with significantly slower growth than the 9.7-per-cent annual level China reached in the first quarter, would put a serious crimp in demand for resources and other imports. Worried investors quickly responded by bailing out of oil, copper, Chinese stocks and other riskier assets and heading for the shelter of U.S. Treasuries and gold.
Consumer prices in China climbed 5.2 per cent in the first five months, and when the figures for June are released next week, they are expected to show an increase from a year earlier in excess of 6 per cent, the fastest pace since 2008. Food prices have climbed dramatically. Chinese officials have acknowledged they probably will not reach their full-year inflation target of 4 per cent.
"Further increases in inflation could invite tougher measures that slice growth considerably," said Cornell University economics professor Eswar Prasad, a former head of the International Monetary Fund's China division. "This would be a blow to the world economy, given how important a contributor to world growth China has been during this recovery."
But Chinese policy makers have been walking a fine line in their efforts to siphon capital out of the market and dampen inflation expectations without damaging economic prospects or the fragile health of China's commercial banks.
"This rate hike still leaves inflation-adjusted lending rates at a level of only around 1 per cent," Mr. Prasad said. "This is a low level for an economy growing at over 9 per cent a year and with rising inflation. Inflation-adjusted deposit rates remain firmly in negative territory, suggesting that the interest-rate structure in China is still far from appropriate."
As a result, ordinary Chinese still have an incentive to spend and invest in speculative assets, although recent efforts to curb bank lending appear to have had a moderating effect on residential property prices, one of the government's policy objectives.
One reason the central bank has not been more aggressive in boosting rates is a concern about the heavy debt accumulated by investment vehicles set up by state and municipal governments. These were part of a wave of infrastructure spending orchestrated by Beijing to counter the effects of the global slowdown that began in 2008. Higher interest rates put considerable pressure on these debt-laden governments, which have heavily lobbied Beijing to limit its monetary policy intervention, said Na Liu, founder of CNC Asset Management and an adviser to Scotia Capital. They also hurt the banks that are on the hook for the low-profit infrastructure loans.
The central bank may in fact be done with interest-rate fiddling for this year, some analysts suggested.
"This interest rate hike will probably be the only big monetary policy move for some time, as policy makers shift more attention to structural issues," Yao Wei, an economist with Société Générale in Hong Kong, said in a note to clients.
For people worried about further Chinese tightening, key data to watch will be the inflation numbers for July and August, said BMO Nesbitt Burns economist Benjamin Reitzes, who expects there may be still be one more hike in the pipeline. The Chinese leadership insists that inflation has peaked. "Assuming they're right, we should probably see inflation coming down."
If not, that hard landing may not seem such a distant possibility.