The People's Bank of China (PBOC), China’s central bank, made a surprising announcement on Christmas day that it will raise the one-year Renminbi (RMB) benchmark deposit and loan rates by 0.25 percentage points respectively.
This unexpected move at the end of year caused widespread speculation. Economist Jian Tianlun believes it will not solve the fundamental economic problems that China is currently facing.
A Forced Move
Dr. Jian Tianlun, a former employee of PBOC and currently an economist in the U.S., believes that the Chinese authorities were compelled to raise the interest rate. This is clearly indicated by two factors, he says.
Firstly, two weeks ago, when the banking industry expected the central bank to raise interest rates, the PBOC, however, raised the required reserve ratio instead. Secondly, the National Development and Reform Commission (NDRC) has recently raised the inflation target of 2011 from the 2010 target of three to four percent. Both indicate that the communist regime still places economic growth as its top priority, controlling inflation being only secondary—though they were made to control it all the same.
“The sudden interest hike now shows that either their decision then was based on political concerns, or that their understanding about the economic situation has now changed. Now that they feel a greater pressure of inflation, they are then forced to raise the interest rate.”
Jian said that inflation usually rises as long as people expect it to, and that this could lead to social instability. In 1988, China's CPI (Consumer Price Index) grew by an alarming 18.9 percent. The rising inflation was one of the triggers of student movement in 1989, which was joined by millions of civilian protesters, and tragically ended in a bloody crackdown by the regime on June 4, 1989.
Jian speculated that perhaps the communist regime found that inflation was getting out of control, and was therefore forced to raise interest rates.
Jian believes inflation will go even higher in 2011. “This is for sure. The NDRC has already set a higher target for inflation. This indicates that the regime has anticipated higher inflation for 2011 and it’s quite possible that inflation will be uncontrollable.”
“Under inflationary pressure, the rate hike is what the regime did involuntarily. They didn't want to do so for fear of increasing the exchange rate. Now they have to do it because, otherwise, the danger and pressure of inflation could be unmanageable.”
Jian also expressed that the interest rate increase is long overdue. Raising rates is better than otherwise and the interest rates can go up another 1 to 1.5 percentage points, in several steps.
Housing Still High
Many experts have an expectation that China’s housing market will cool down as a result of the rate hike, but Dr. Jian disagrees.
He indicated that raising interest rates can help restrain housing bubbles but remains doubtful as to whether housing prices will decline as a consequence. “Because the rate hike is small it will not have a big impact. Besides, there are many other factors affecting the housing market.”
Jian then turned his attention to the rapid rise in Chinese housing prices over the past few years.
The number of single people of marriable age reached a trough in 2004, and then rapidly increased. Traditionally, a man would not marry until he had a house, which has led to an increase in demand for housing, pushing up China’s housing prices.
China's real estate markets vary from place to place. Shanghai, Beijing and other major metropolitan cities experienced higher increases. Other than the structural change (the increase of singles looking to marry) and migration towards major cities, speculation and investment demands are also affecting the property markets.
Jian pointed out that according to data from China’s Bureau of Statistics, the rigid demand—population of marriable singles—will reach a peak in 2012 before going down. However, this does not necessarily mean that the property market will continue rising to 2012: investment demand, speculation demand, changes in interest rates, and the economic environment can also affect the property market.
Jian said that raising interest rates are an important part of correcting the Chinese economy, else it overheat, but also pointed out that interest rate hikes can't solve the fundamental problems. “The fundamental problems that China is facing are the bubbling and distorted economy, along with income inequality and an irrational economic structure. There is no way to correct the Chinese economy if these other issues remain unaddressed.”
Jian emphasized on many occasions, that the RMB undervaluation is a major issue, and that RMB appreciation will help to solve some of the fundamental economic problems.