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For a Quality Recovery [in China], Raise Interest Rates



May 12, 2010 – Comments (4) | RELATED TICKERS: FXI

"Unlike the frigid European economy, the Chinese economy continues to steam ahead. But in the area of macro economic policy, China seems to be lagging. We think the time has come for a meaningful policy adjustment: China should raise interest rates.

"No one doubts that Chinese policymakers can get some things done. The government flexed its muscles recently by taking steps to control a property bubble and reduce excess liquidity.

"A series of real estate policies were enacted to cool the property market. And on May 2, the People's Bank of China increased the bank reserve requirement for the third time this year, forcing large financial institutions to maintain a 17 percent reserve rate – close to the all-time high 17.5 percent reached in June 2008. According to sources, the central bank in effect froze more than 1.7 trillion yuan.

"Clearly, the government's orientation is toward a moderate tightening of monetary policy. But this is worrying in light of an absence of exchange and interest rate policy measures. Undoubtedly, exchange and interest rate adjustments offer the most direct monetary tools for managing property bubbles and inflation expectations. And for some time, China's regulatory agenda has included calls for revisiting exchange rate policies. But the right moment for enacting this plan has yet to arrive. Besides, any adjustment would have only a limited effect on short-term liquidity.

"What concerns China even more are interest rates. Against the nation's inflation rate, real rates are currently in negative territory.

"A well-timed rate hike would serve to keep the property bubble in check and better balance the costs of capital."

The article in its entirety:

4 Comments – Post Your Own

#1) On May 12, 2010 at 5:04 PM, Seansonfire (41.53) wrote:

Great post even it was pulled from an article, at least I only had to read the relavent stuff.

 +1 Rec

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#2) On May 12, 2010 at 5:15 PM, Melaschasm (70.28) wrote:

I disagree.  By increasing reserve requirements China is tightening their monetary policy.  At some point China will benefit by allowing the yaun to appreciate a little bit against the dollar.  However, there is not a big rush to do so. 

IMO China would benefit more from a reduction in government spending, which would reduce inflationary pressures, while improving China's fiscal strength.  This woud give China the flexibility to cut taxes, increase spending, or reduce reserve requirements if the need to stimulate the economy should arise.

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#3) On May 12, 2010 at 5:22 PM, ElCid16 (94.50) wrote:

#2  "However, there is not a big rush to do so."

The rate that real estate is rising would suggest otherwise - if they are to prevent an enormous real estate bubble.  Some have argued (even here on CAPS) that the rapid rise in real estate is already a bubble waiting to burst.  To simply leave interest rates where they are could prove to be very costly for China...

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#4) On May 12, 2010 at 7:58 PM, ChrisGraley (28.51) wrote:

They need more than this, but it's a good beginning.

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