Much has been made of the central bank’s decision last Friday to raise benchmark one-year deposit and lending rates by 27 basis points, with almost all analysts taken by surprise.
Even the Sino-foreign investment banking joint venture China International Capital Corporation (CICC) – apologies to Morgan Stanley which is more foreign than it is joint venture in the relationship these days - which could be expected to have an inside line somewhere to the central bank got caught out, arguing in an August 17 report that there was unlikely to be further tightening this year. Others, like Deutsch Bank’s Jun Ma, have recovered their poise and said they saw it coming, but just not so soon.
This writer was lucky enough to have time to retract and alter an article due to appear in September’s CER arguing no further rate hikes would be seen, with the bank more likely to drain liquidity from the system by reserve ratio hikes than attempt to use rates to peg back demand.
However, re-writing my story didn’t change my central argument, which made me realize that in China, the price of money is almost irrelevant. The banking system is not fully functioning and the interest rate transmission mechanism is, to put it bluntly, buggered. In short, rate hikes just don’t matter.
Which is just as well. In a functioning market economy, increasing rates has the effect of slowing an economy. Given China’s efforts to boost domestic spending, this could simply put the cosh on slowly improving import figures, blowing out the trade surplus further and accelerating the inflow of foreign exchange. With sterilization measures already fully stretched, that will mean more money in the system.
Luckily, China doesn’t work like that. What is important is the supply of money, and China already has too much spare cash floating around in the system. Administrative fiat is about the only way to clamp down on this, although the introduction of dividend payments would be a useful way of diverting retained earnings from fixed-asset investment, redistributing it into public spending in areas like health and education.
By increasing the safety net for China’s 800-odd million rural poor, the flow on effect will be a boost to private consumption as until-now scared-to-shop Chinese find the consumer at their recently communist-heart.
Anywhere you turn these contradictions exist, and China’s central bankers have a fine line to walk if they hope to rebalance the economy. But in doing so, they cannot afford a slowdown, which raises the fears, and the ire, of those predicting impending asset bubbles and an inflationary backlash, among a wealth of other macro-fiascos.
With a modest rate hike, the central bank gets the best of both worlds. First it appeases the macro-hawks calling for action, while sleeping soundly at night in the knowledge that the rate hike doesn’t really matter a damn.
All the hike really does is highlight the PR in the PRC.