International | Aug 22 2006
By Chris Shaw
The more experts analyse China’s latest move to slow its economic growth via last week’s increase in official interest rates the more opinion reaches a single conclusion – by itself the move is not enough and more is yet to come.
The best explanation as to why further moves are required comes from Morgan Stanley’s Stephen Roach, who points out while China’s economic system remains fragmented between the State and markets thanks to an underdeveloped banking and financial markets system, the implementation of policy from a central authority is always going to be less effective than would be the case in more developed markets.
As evidence of this he points to the fact within China’s 31 provinces eight have been experiencing hyper-growth, being responsible for 72% of the country’s total economic growth since 2000. This split means government policy is not as effective as it should be given a blanket approach is being taken that is not reigning in these faster-growing regions.
The other problem he points out is the banking system continues to hold excess reserves, meaning lending controls are proving ineffective in actually slowing down the amount of money being lent and invested. Dealing with this in his view will require central planners to introduce more administrative controls to limit the quantity of investment, exports and industrial activity.
In his view this will come via a three-pronged cooling off strategy, involving an expansion of administrative edicts which could include measures such as the removal of tax incentives or the implementation of surcharges in particular industries, an increase in the pace of reform in the banking sector and further macroeconomic constraints, which includes further increases in interest rates.
Colleague Andy Xie agrees, forecasting a further 0.27% increase in rates this year and a total increase of between 135-162 basis points by the end of 2007 as the government addresses the issue of rates that are simply too low for the current growth environment.
ABN Amro agrees a further rate increase by the end of the year is likely, noting one possible benefit of the latest increase is the likelihood it will go some way to addressing the current issue of a mismatch between borrowing and lending maturities, which could cause problems in the banking sector down the track.
SB Citigroup also agrees further moves are likely, but points out success in slowing the economy will require measures such as a widening of the trading band for the currency, which would be a precursor to a revaluation. It is a view shared by JP Morgan, who argues the rate moves will continue to have only limited impact as the key issue remains excess liquidity, which is only likely to be addressed by changes in the level of the exchange rate.
Consensus therefore appears clear, expect further rate increases in China but also expect greater reforms and measures as China continues to fight a losing battle in terms of slowing down the rate of growth in its economy.
