The prevailing view among Chinese economists is that China's central bank will have to raise interest rates to prevent a runaway economy and soothe growing inflationary pressures if the ongoing excess investment cannot be stopped. 
 
Li Yang, a member of the central bank's monetary policy committee, says China may raise interest rates if the consumer price index climbs above 5 percent:

"Whether of not there will be a hike in interest rates really depends on the economic trend. If the Central Bank failed to curb over-investment in such sectors as steel, property, cement and aluminum by other means, it would resort to rate increases just as developed countries have had to meet similar situations."

He says the central bank is concerned that an inflation rate higher than the one-year lending rate, currently around 5.3 percent, may exacerbate price rises by encouraging companies to borrow and stockpile materials for profit. China's inflation accelerated to a seven-year high of 3.8 percent last month. China's investment in factories, roads and other fixed assets jumped 43 percent in the first quarter. In fact, Central Bank Vice-Governor Wu Xiaoling admitted earlier that the inflation rate may approach 5 percent in the three months starting in May because of last year's SARS epidemic, which depressed prices in the comparable months.

Qiu Zhaoxiang, director of the financial research institute of the University of International Business and Economics, agrees:

"The central bank is waiting to see if the monetary methods it has taken -- largely increases of bank reserve requirements three times in a row since last September -- will yield the ideal results, before a decision on interest rates rises is made."

In a latest central bank move, commercial banks' reserve requirement was raised to 7.5 percent from 7 percent beginning April 25, meaning a loss of over 13 billion US$ in their available funds that could otherwise be used for lending. China still orders commercial banks to park part of their deposits in the central bank to guard against future operation risks.

Meanwhile, economists point out that the central bank, however, still has worries because interest rate increases would lure even more overseas capital into China to cash in on the already big rate gaps between Renminbi and foreign currencies including the US dollar, resulting in heightened pressures on Renminbi appreciation. China's foreign-exchange reserves, the world's second biggest after Japan's, rose to a record US$440 billion at the end of March.

If more so-called "hot money" flows into China, the central bank will purchase it under the current stringent foreign exchange administration by releasing more Renminbi base money. However, such a move would offset its efforts to rein in the money supply.

So, experts believe the central bank will announce rate hikes --if needed -- after the US Federal Reserve does.

In a newly-released report, the People's Bank said in a much softer wording that its prudent monetary policy stance will be tilted towards "moderate stringency" in the near term, vowing to take measures to mop up liquidity in the country's financial system to prevent loan growth which was still in the fast lane.

(CRI May 24, 2004)