China's central bankers are just a few days away from passing one of their toughest years since the start of economic reforms in the late 1970s.

Their unexpected announcement of a long-anticipated interest rate rise in October surprised nearly all market observers, and sent ripples across the world's major financial markets.

While how much the rate hike can do in cooling down an overheated economy remains to be evaluated, officials at the People's Bank of China (PBOC) now find themselves at the doorstep of another 12 months of data gazing and policy weighing.

With the nation's fiscal policy downshifting to a "prudent" stance from a few years of expansiveness, monetary authorities are forced onto a more difficult tightrope in the new year of balancing between containing the overheating tendencies in the economy and preventing an abrupt slowdown.

The government has reportedly set its economic growth target for next year at a still strong 8 percent, though down from this year's estimated 9.3 percent.

Yet no consensus has been reached, even on new loan growth, one of the first indicators the central bank watches when contemplating monetary policy. Xia Bin, director of the Institute of Finance and Banking under the State Council's Development Research Center, predicts the central bank's target for 2005 will be 2.3-2.4 trillion yuan (US$277-289 billion), or an annualized 14 percent growth, up moderately from this year's real growth but lower than the target.

"My expectation is that the central bank's renminbi lending growth target for 2005 will not be the 17-18 percent some have calculated with models," Xia, a former PBOC official, told the China Economic Times.

The PBOC, which has said it will continue to maintain a "prudent" monetary policy next year, is expected to announce its loan growth and money supply targets for 2005 in January.

The reason for sharply differing views among economists is not due to the usage different economics theories. The Chinese economy has been churning out only mixed signals as to where it is heading.

Import growth has slid significantly from earlier months to 22.1 percent and 29.3 percent in September and October respectively, a sign economists see that the State's macro management has worked in cooling down strong, if not heated, domestic demand.

The faster-than-expected decline in money and loan growth, which analysts say resulted in liquidity difficulties especially in small businesses, has also prompted worries about a policy overshoot. The growth of broad money M2 dipped below the year-long target of 17 percent to 13.5 percent at the end of October, after hovering at levels above 20 percent for months early this year.

Still, there are indications that a "soft-landing" is far from achieved. The growth in fixed asset investment, which slowed down from blistering paces of 40 percent earlier this year to 27.7 percent for the first three quarters, is still faster than the 26.7 percent for last year, when worries about overheating arose.

A more worrying sign is that the producer price index (PPI), a leading indicator of price pressure, has remained stubbornly on an upward curve since last year, even after investment growth slackened its pace in May, according to Li Mingzhi, a researcher with the National People's Congress.

Looking forward, the already bewildering economic picture may get even more complicated next year with new uncertainties emerging, economists said.

This year's credit-tightening measures, stricter punishments on loan losses as well as the absence of an appropriate mechanism to encourage loan extension, has given rise to a widespread reluctance among the nation's four State-owned banks to grant loans, which threatens to undermine necessary monetary growth, said Wang Songqi, a senior economist with the Chinese Academy of Social Sciences.

"For the Chinese economy to avoid a hard-landing, the key is on the banks," he said. "As long as there is no persistent 'loan stinginess' in the banking system, particularly at the four State-owned banks, the economic growth will not slide abruptly."

Investment growth may also accelerate, with fixed investment projects cancelled during this year's consolidation accounting for only a surprisingly low 1 percent of all areas suspected of excess investment.

"The enthusiasm to expand investment remains strong across the country, and there is a possibility that fixed investment growth may rebound," the PBOC said in its third quarter monetary policy report.

What also remains to be seen, economists say, is to what extent the upward pressure on PPI will pass on to the consumer price index (CPI), the key barometre of inflation, and when that will happen.

Although the CPI had accelerated from January's 3.2 percent to 5.2 percent in September, economists say the increase could have been far bigger if China's price transmission mechanism is more effective.

It's a tricky situation. While high consumer prices will erode people's living standards, sharp differences between producer prices and the final prices threaten to significantly reduce corporate profits and disrupt economic growth.

A lot has to do with how the central bank diagnoses the continuing flow of economic data, and what prescriptions it gives. One encouraging improvement, analysts say, is that the risk of policy overshoot due to the use of administrative measures is reduced, with the central bank's interest rate rise in October signaling a shift to more "price-oriented" and market-based macro management methods.

"Although the quantitative methods managed to bring down monetary growth quickly, the systemic problems that caused overheating are far from solved," said Li Ruoyu, an analyst with the State Information Center. "Price-type instruments need to be fully used to reinforce what has been achieved."

It is everybody's guess as to when the PBOC will adjust interest rates again, or use other monetary policy instruments, but the bank clearly has more elbow room next year than this year, as the United States is expected to continue raising rates, analysts say.

One key concern for China's monetary authorities when raising interest rates was that it may broaden interest rate differentials with the international market, and subsequently amplify foreign exchange inflows that have already been more than wanted and increased the upward pressure on the renminbi's exchange rate.

The US Federal Reserve's rate increases this year have already brought its rate level basically at par with that in China, and it is widely expected to continue raising rates further next year and bring the US level above Chinese rates.

The hefty forex inflows in recent years, largely attracted by China's higher interest rates and expectations for an appreciation of the renminbi, have already complicated China's monetary policy operations by forcing the PBOC to increase money supply when it purchases excess dollars to enforce a narrow floating band of the yuan.

(China Daily December 27, 2004)