The Chinese government has used a number of measures - including raising bank reserve requirements, reining in lending to overheated sectors, adjusting industrial policies and implementing price controls - to cool the red-hot economy, which grew 9.8 percent in the first quarter. However, economists and industry insiders are arguing that an interest rate hike will be needed to secure a soft landing for the Chinese economy. The pressure may lead the central bank to raise interest rates for the first time in nine years.

"We are hesitant and slow to react to overheating," wrote Hu Shuli, the chief editor of Beijing-based Caijing Magazine.

The debate on overinvestment started last year, but most officials and economists believed that China's economy was healthy at that time. GDP grew 9.1 percent last year, despite the SARS epidemic.

It wasn't until early 2004 that the issue was put at the top of the State Council's agenda. Excessive investment has aggravated coal, electricity and oil shortages, hampered structural optimization of the economy and heightened inflationary pressures. The People's Bank of China (PBOC), the nation's central bank, raised bank reserve requirements twice in March. The China Banking Regulatory Commission also issued regulations to curb lending in some overheated sectors like steel, real estate and aluminum.

These measures seem to have had a limited impact on the soaring economy. China's GDP still swelled 9.8 percent in the first quarter. Fixed asset investment reached 879.9 billion yuan (US$106.0 billion), up 43 percent year-on-year. The April consumer price index (CPI), an important inflation gauge, also jumped to 3.8 percent, compared with 2.8 percent for the first quarter. As for lending, the central bank said in its recently released monetary report that money supply in the first quarter grew 17 percent and new loans reached 2.6 trillion yuan (US$313.0 billion), the second highest in history.

"The facts prove that these measures have had little impact on the overheated economy," wrote Hu. "It will be hard to curb inflation unless more effective tightening policies are adopted."

The Economic Observer, a well-known business newspaper in China, put the issue on its front page last week, under the somewhat desperate title of, "Interest Rate Rise, the Last Tool."

With the exception of a rate hike, the central bank has done everything it can to cool the national economy and maintain RMB stability, the article said.

Meanwhile, the government has intervened in lending, fixed-asset investment and pricing.

In April, the State Council called for attention to some new problems in the economy, especially excessive investment in fixed assets and shortages of coal, power, oil supplies and transportation facilities.

Also in April, construction of a major steel smelting facility in east China's Jiangsu Province was brought to a screeching halt for alleged illegal land expropriation and borrowing. The move is widely believed to have been part of the effort to halt undesirable construction in an overheated sector.

The State Development and Reform Commission also conducted a nationwide price inspection. Local governments were told to halt utility price hikes if inflation in their areas gets out of hand.

However, the intervention was criticized as excessive.

"The fundamental reason for overinvestment is an immature market system," said the Economic Observer article. "The target of government intervention is to curb government-dominated investment, but other things should be decided by market forces and macro-economic measures."

Hu Shuli also warned, "Government intervention in the economy contradicts China's market system reform, and since the central and local governments have different objectives, intervention does not have the intended result. Instead, it increases the risk of a hard landing."

But the government's intervention does indicate the urgency of its desire for a soft landing, making the possibility of an interest rate adjustment that much stronger. Economists and many industry insiders have voiced their expectations of a hike.

"If the CPI stays at the 3-percent level or higher in the coming months, there would be a possibility of raising the interest rates," said China Securities economist Zhu Jianfang in a China Daily interview.

Yuan Gangming, a senior economist with the Chinese Academy of Social Sciences, reportedly said the government should already have raised interest rates to deal with the increasing inflationary pressure.

But Yi Xianrong, another economist at the academy, takes a dissenting view. He said there is little possibility that the CPI would rise rapidly and thus, "There is no need to adjust the interest rate to balance demand and supply." Yi said that current price levels are bearable and actually create a better environment for the reform of state-owned enterprises.

In its monetary report, the central bank takes a wait-and-see attitude. Although at an April forum PBOC Governor Zhou Xiaochuan and Vice Governor Wu Xiaoling denied any immediate plans to adjust interest rates, everything suggests that a hike will be the tool of last resort if current policies fail. Even at that time Wu admitted that, "If the inflation rate keeps rising, leading to an actual negative lending rate, the central bank would consider raising lending interest rates from the current 5.3 percent."

At this week's Beijing International Finance Forum, Zhou said that the central government is continuing to monitor prices and keeping a close watch on the CPI. China's interest rate, slashed eight times in the past nine years, is at a historical low. The benchmark one-year bank deposit rate is now set at 1.98 percent.

"At present, the most direct and effective way is to raise interest rates," wrote editor Hu Shuli. She added that although a rate hike would have an impact on the domestic stock market, real estate and banks, it is the last chance to achieve the soft landing goal. "We can't lose that chance," she wrote.

"According to my observation, the lending rate will be raised if necessary, especially for the medium- and long-term loans," Wang Mengkui, director of the State Council Development Research Center, told the Economic Observer.

But the central bank is reluctant to lift deposit rates before the US Federal Reserve raises its interest rates. "The PBOC is afraid of foreign capital inflow and resultant pressure on the renminbi rate," the Economic Observer reported.

(China.org.cn by Tang Fuchun May 20, 2004)