China increases interest rates

The Central Bank of China has raised the interest rates. It has raised the seven-day reverse repurchase rate to 2.5 per cent while that for the 28-day reverse repurchase rate was increased to 2.8 per cent.

Background

China is the second largest economy in the world after USA. According to certain forecasts, its GDP growth is slated to overtake America’s GDP in another 10 years. A hub for manufacturing industry, China is the fastest growing economy. Its economic growth has been over 10% for over 30 years.

However, in the recent years, China’s exponential growth has come at the cost of increased debt. According to statistics, its debt is more than 250% of the GDP and is much higher than the US. It is, however, lower than Japan, which remains the world’s most indebted leading economy. Experts have said that if China’s trajectory continues, then it will be looking at an economic slump sooner than later.

The People's Bank of China is the central bank with the power to carry out monetary policy and regulate financial institutions in mainland China. Since July 2017, the People's Bank of China has the largest financial asset holdings of any central bank in the world.

Analysis

On December 2017, for the third time in the year, the US Federal Reserve raised the interest rates by 0.25%. The central bank noted that this was introduced as the US economy had made “solid gains.” Surprising financial analysts, hours later, the Central Bank of China also announced that it will be raising its interest rates. The bank has raised the seven-day reverse repurchase rate to 2.5 per cent while that for the 28-day reverse repurchase rate was increased to 2.8 per cent. China also boosted rates on another policy tool, the standing lending facility.

China’s rate adjustments "help markets form reasonable expectations for interest rates," the PBOC said in a statement. The bank also argued that it also prevents financial institutions from adding excessive leverage and expanding broad credit supply.

Raymond Yeung, chief economist, Greater China for ANZ said, “The PBoC’s rate hike offers little surprise following the US Fed rate hike overnight. The move is in line with our expectations of an uptrend in China’s policy rate, although the timing is a bit earlier and the pace is smaller than what we had expected. According to the PBoC’s press release, the hike is a response to the market uptrend and to contain leverage. We now expect the PBoC to hike rates by 35bps in total in 2018 to take the 7-day reverse repo rate to 2.85% by the end of 2018. We have been calling for a total of 40bps rate hikes by the PBoC in 2018 on the back of domestic financial deleveraging, rising inflation and steady growth.”

"This action seems to follow the Fed," said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. "Since it only lifted the rate by just five basis points the central bank does not want to jeopardize the market with an aggressive hike. It does indicate the tightening bias of the policy makers and this stance will continue in 2018."

The world’s second-biggest economy has defied market expectations with economic growth of 6.9 per cent in the first nine months of the year, supported by a construction boom and robust exports. China’s fixed-asset investment growth slowed to 7.2 per cent in the January-November period, while industrial output expanded at a faster pace than markets had expected.

Assessment

Our assessment is that the latest rise in interest rates is perhaps due to the US Federal Reserve’s rate hike. We also feel that the government will pursue a range of policies to lower leverage and debt in the economy. We sense that the objective of the rate hike would be to bridge the gap between short term and long terms rates; to curb from using short term loans and to invest long term debt by overly adding leverage.