Structural problems emerged in China's macroeconomic performance in the latter half of 2003.

These problems only worsened in the first half of 2004.

In pursuit of big profits, some sectors - particularly steel, cement and aluminium - witnessed investment growth that was obviously too quick, which led to expansive loan extensions and gave rise to inflationary pressures.

The Party and the State Council were quick to take actions to dissolve the risk of a partial overheating of the economy, producing desirable economic and social effects.

Reflecting on this round of macro management, the differentiated approach of "contain some sectors while keeping others" stands as an inevitable choice given the existing structural imbalances.

Monetary policy, as one of the two macro management policies that are prevalent in many countries, are typically seen as an aggregate-targeting policy.

As part of the monetary policy, the interest rate policy not only has the characteristic of having an undifferentiated effect on all sectors, but is modest in comparison to other monetary policy tools like reserve ratio. The effect of moderate interest rate hikes tends to be neglected, especially when it comes to the problem of excessive investment growth in such high-profit sectors of steel, cement and aluminium.

However, in the context of current economic growth, we can see that the interest rate has its role in addressing the structural problems facing the current phase of growth.

As we know, urbanization and industrialization are the two essential engines of the current economic growth.

The migration of farmers into the cities and urbanization are bringing prosperity to the real estate sector nationwide.

Meanwhile, industrialization, driven by an upgraded consumption structure, brings automobiles into Chinese households.

Obviously, the rapid growth in real estate and auto industries needs huge amounts of steel, cement and aluminium, where soaring investment has stretched supplies in upstream sectors such as coal, electricity, oil and transportation.

That means, if downstream sectors - such as real estate and automobile - can maintain stable growth, the excessive investment growth in upstream sectors could be brought under control.

At the same time, large commodities, housing and autos are bought by installments, with mortgages in China for as long as 30 years.

On the one hand, should interest rates climb, consumers who buy homes on credit may give up their plans to avoid extra costs.

On the other hand, since real estate developers borrow a big part of the funds for land purchase and construction, higher interest rates inevitably raise their costs too.

Therefore, interest rate adjustments can not only put a lid on bubbles on the supply side, but contain insensible demand from consumers - meaning the real estate sector is very sensitive to interest rates.

Similarly, higher interest rate levels can also make potential auto buyers delay their plans.

Based on the reasoning, higher interest rates will, first, reduce demand in downstream sectors of real estate and auto, then bring down investment in upstream sectors of steel, cement and aluminium, and therefore soothe bottlenecks in coal, electricity, oil and transportation.

In other words, we should not only take note of the direct impact of an interest rate increase on the costs in high-growth sectors, but pay more attention to its ripple effects.

On October 29, 2004, the central bank slightly raised benchmark rates for the first time in nine years, but interest rates remained at low levels.

After the bank raised rates on property loans on March 17 this year, lending rates on five-year-upward mortgage loans are only floating in the 5.51-6.12 per cent range, while the lending rate on five-year-upward loans from housing provision funds stands at merely 4.41 per cent, which is lower than that on regular loans.

Therefore, the central bank has ample room in the future and can continue to raise rates on either mortgage loans or regular loans when necessary. Even in the event of minor adjustments, they may produce "unexpected" effects on addressing the structural problems in the economy.

The growth of money supply in China kept in the range of 13-14 per cent since the latter half of last year, which is quite limited. As experience suggests, such growth rates of the money supply do not match the low interest rates we have currently.

What deserves attention is that this tightness in money supply is different from a similar phenomenon a few years ago in terms of internal causes.

Signs of deflation were obvious between 1998 and 2002, and the momentum for organic economic growth weakened with banks getting cautious with lending and businesses becoming reluctant to borrow.

With the slowdown in credits being largely a result of micro entities, the interest rate policy could hardly play its role of kickstarting economic growth. Differently, the relatively slow growth in the money supply is largely caused by high-growth businesses that need money but are restricted by credit curbs while those which are free from credit curbs do not need to borrow more given the poor returns.

China's real interest rates remained in the negative territory in most months since the beginning of last year, which has increased calls to raise interest rates.

The decision depends on both the growth of the money supply and inflation, especially the latter, which is the ultimate goal monetary policy serves.

Up to now, the money supply growth has not surpassed this year's cautious 15 per cent target set by the central bank, lending little support for an interest rate increase.

Given the 4 per cent target growth for the consumer price index this year, a single-month year-on-year growth of CPI going beyond 5 per cent may justify a moderate rate increase if mostly-adjusted growth is positive, while three consecutive months of 5 per cent upward year-on-year CPI growth can support a heftier rate hike.

But those conditions have not yet materialized.

The reason that the timing for a further rate increase is not yet ripe despite negative real interest rates is that the credit curbs are binding the feet of interest rate policy.

There is no doubt that credit curbs can be necessary in macro management, and are able to produce immediate effects in containing problems and malicious tendencies in the economy.

But such methods should be used as little as possible, and can be replaced with market-oriented measures when possible. That is because credit curbs require interference in the behaviour of microeconomic entities, which clashes with the gist of China's market reforms.

Also, since credit curbs are enforced by human administration (instead of systemic arrangements), they tend to be reduced over time to the level of a simple ritual.

In summary, there is a need to loosen credit curbs as soon as possible, and shift to more market-oriented methods when addressing problems in economic growth.

In fact, with the momentum for economic growth remaining strong, lifting credit curbs will, to some extent, result in a rebound in money supply growth, which provides a good opportunity for the interest rate policy to play its role.

(China Daily April 11, 2005)