Yi Xianrong
On March 17, the People's Bank of China, the central bank,
announced a 0.27 percentage point hike in key interest rates. This
was dictated by current major economic indicators.
Macroeconomic readjustment policies in 2006 seem to have not
worked effectively to put a brake on runaway real estate
prices.
If housing prices keep rising rapidly, the ongoing increase in
property investments is not expected to slow. As a result,
overheated fixed asset investment will continue and, in turn, ever
expanding bank loans will keep gaining momentum.
In addition, the banks are feeding growing real-estate
investments with their readiness to make loans.
Starting from the latter half of 2006, the central bank,
confronted with overheating investment, rapid growth in bank loans
and increasing trade imbalances, implemented a host of
macroeconomic readjustment policies. To slow growth in bank loans,
the central bank raised the deposit reserve ratio and required
market operations to be more transparent.
However, these policies had limited effect.
The price mechanism is at the core of the market infrastructure.
This means that the relationship between supply and demand is
modulated by the price.
In the monetary market, the price of capital is nothing more
than the interest rate. The price mechanism works in the form of
interest rates' ups and downs.
In China, whose economic set-up is still in transition from the
planned economy to a market oriented one, the price mechanism is
still at the core of the general economic operation.
Currently, many problems in the Chinese economy have their roots
in the low-interest-rate policy. It leads to overheating in fixed
asset investment and excessive growth in the country's favorable
trade balance.
In the context of low interest rates, it is profitable for
investors to borrow money from the bank. The investors, who borrow
low-cost money, feel no restraint in investing in high-risk
projects. The capital easily flows into economic operations,
particularly real estate and the stock market. Under such
circumstances, it is only natural that stock and real estate prices
keep soaring.
The central bank's latest interest rate hike by 0.27 of a
percentage point may be insignificant beside the 16.8 percent
investment return ratio seen by the average Chinese enterprise,
even more so beside the fat profits reaped by real estate
developers. But the interest rate rise is aimed at gradually
changing the government's low-interest-rate policy, upgrading the
government's macroeconomic readjustment tools and bringing down
enterprises' and individuals' expectations for easy profits.
Taking all this into account, the role played by the interest
rate hike is important.
We will soon see that higher interest will have significant
impacts on the real estate market, though it will have limited
influence on most enterprises and other markets. To be more exact,
people who borrow money to buy housing for themselves or for
investment will be affected most, rather than property
developers.
Take Taiwan. Real estate prices shot up three times in a short
period of time in the 1980s and 90s, fueled by a low interest
policy and appreciation of the Taiwan dollar. This trend was,
however, reversed by the rise of interest rates in the 1990s. By
2003, the housing price had dropped by more than 60 per cent.
In Hong Kong, real estate prices plummeted by 67 percent between
1997 and 2003. The price has, however, shown signs of rising in the
last couple years when interest rates are lower.
The same can be expected on the Chinese mainland. An interest
rate hike not only increases costs for real estate developers and
investors but also dampens the high expectations of individuals who
buy housing for themselves or for investment. Particularly, when
they anticipate that the central bank will adopt a package of
austerity policies with respect to the property market, they are
likely to withdraw from the market. Their pullout will bring down
the demand for housing. If the supply remains the same, the
dwindling demand naturally brings down real estate prices, helping
to cool the overheated housing market.
In sum, the interest rate is the most effective instrument for
macroeconomic readjustment. Although a small margin hike in
interest rates plays more of a warning role than actually cooling
off the market, it has great influence on the real estate market,
especially on people who borrow money from the bank to buy
houses.
It is hoped that, with this as a turning point, the central bank
will really switch to implementing price-mechanism-oriented tools
in macroeconomic readjustment.
The author is a researcher with the Institute of Finance and
Banking at the Chinese Academy of Social Sciences
(China Daily March 21, 2007)