China tightens too little and rather late

February 8, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — When China raises rates, speculators quake. Tuesday’s after-hours rate hike had a near instantaneous effect on global markets, sending copper back below $10,000 a tonne, and crude oil below $100 a barrel. If only the Chinese economy were so responsive.

China has good reason to tighten monetary policy. The economy is overheating, with GDP growing at an alarmingly high annualised rate of 9.8 percent rate in the fourth quarter. Domestic demand remains prodigious. The recent PMI survey, where managers give their view on the state of business, showed that economic activity remains very strong indeed.

As well as a reason, there is an opportunity. Yields on U.S. 10-year Treasuries have risen to nearly a nine-month high, reducing the theoretical profits from borrowing in dollars and investing in China. That means a rate rise is less likely to attract dreaded “hot money” — though China’s tough capital controls make that something of a paper tiger.

But the mini rate hike won’t push real deposit rates, now at negative 2 percent, into positive territory. Savers still have little incentive to put money in the bank. Nor will it curb the inflationary lending habits of banks. They lent $76 billion in the first week of January alone, and their behaviour is more sensitive to balance sheet capacity than changes in the marginal price of debt.

Higher rates also won’t do much to tame rapidly rebounding exports. The recent PMI survey showed export orders, adjusted for seasonal oddities, expanding at their fastest pace in a year, according to Goldman Sachs. No wonder: China has so far passed up the opportunity to tighten exports, and encourage a rebalancing of its economy, through a decisive revaluation of its currency.

Bank lending, roaring demand and real deposit rates will no doubt get their turn for focused tightening. Expect further rate hikes, property curbs and much fatherly advice — all choreographed, like the latest hike, to avoid shocks. The trouble is that sometimes, when inflationary thinking takes root, only a shock will do.

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