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| Li: "destabilizing" effect |
China must immediately hike interest rates and appreciate its currency to combat asset bubbles and boost household consumption, a member of the Chinese central bank’s monetary policy committee has said. The call comes amid rising fears that China’s reluctance to raise borrowing costs – that could potentially trigger a surge in corporate and public indebtedness – is derailing the rebalancing of the global economy.
“Low interest rates are potentially very dangerous for the Chinese economy...and could be deeply destabilizing in the long-term,” Li Daokui of the People’s Bank of China (PBOC) monetary policy committee told Emerging Markets.
Analysts expect the PBOC to hike commercial banks’ deposit and lending rates only at the second quarter of 2011. The one-year certificate of deposit rate stands at 2.25% but is negative in real terms, after adjusting for inflation.
Li said: “We are creating expectations that the real interest rate on the deposit side will be negative for a long time. This is inducing depositors to invest in the equity, property and foreign markets.”
Speaking in an independent capacity, as economics professor at China’s Tsinghua University, he added: “Excessive and uneven lending in China can only be mitigated by proper increases in lending and deposit rates.”
Li said that “in an ideal world, in which there were no politics and just economics”, the deposit rate should be increased to 50 basis points (bps) above the consumer price index, followed by the lending rate. In addition, the renminbi should appreciate 3% to 4% a year.
This moderate pace of currency appreciation and interest rate hikes would “not cause disaster and would help smooth adjustments”, as the economy shifts to lift consumer purchasing power and domestic demand.
China’s economic model is partly based on artificially cheap capital – which boosts the exporting industries – that subsidizes investors but effectively taxes depositors, he said. The result of “lower disposable household income is creating China’s low ratio of consumption,” said Li.
China is in the line of the fire as the Europe, US and the IMF step up their demands on the government to boost domestic consumption, which represents 36% of GDP, half that of the US.
IMF chief economist Olivier Blanchard said in Washington yesterday: “Many emerging countries, here most notably China ... must now turn more to domestic demand. These adjustments are essential to maintaining a strong and balanced recovery.”
Low interest rates have fuelled a rapid expansion of credit in real estate, equity markets and construction, exacerbated by the government’s stimulus policies in response to the global crisis that resulted in a credit boom and misallocated credit.
“Only artificially-low borrowing costs...allow these investments to remain viable,” said Michael Pettis, finance professor at Peking University.
Raising interest rates would discourage over-investment – but risks triggering defaults in the short term. Pettis said low interest rates transfer every year 5%-10% of China’s annual GDP away from householders to capital investors.
“The risk in that case is of a Japanese-style stalemate, in which for many years the authorities are forced to keep rates too low because they simply cannot countenance the alternative, and during this time consumption growth continues to struggle.”