China Tugs on the Reins Again

Expect more moves from Beijing on top of a 27-basis-point interest rate hike, which comes one day after reporting white-hot GDP growth

In a widely anticipated move, the People's Bank of China announced July 20 it will raise interest rates just one day after China reported its fastest economic growth in 12 years. The benchmark one-year lending rate will be raised to 6.84%, up from 6.57%, and the one-year deposit rate will rise to 3.33% from 3.06% starting July 21. This follows two previous rate rises already this year. China also announced it will cut its tax on interest income, from 20% now to 5% as of Aug. 15.

The moves come as no surprise following China's heated second-quarter gross domestic product growth of 11.9%, which puts the mainland's already $2.8 trillion economy on track to exceed Germany as the world's third largest by yearend. On July 19, China's National Bureau of Statistics also reported 25.9% growth in fixed-asset investment into power plants and public works in the year's first half; and 4.4% reported consumer price inflation for June.

Don't expect this rate rise and tax cut to be the last policy tweaks, however. While China wants its economy to grow fast enough to create new jobs for its farmers and workers, it is wrestling to keep the economy from overheating and this latest increase is unlikely to have a serious cooling effect.

Yuan Revaluation Expected

Given that much of the current investment spending boom is driven by companies' retained earnings, China's economy is relatively "interest rate insensitive," pointed out Glenn Maguire, the Hong Kong-based chief Asia economist for Societe Generale in an interview with BusinessWeek just after the GDP figure was released July 19 but before the interest rate announcement.

That has many analysts expecting a revaluation of the yuan later this year, with Maguire predicting a jump of 3.5% or so in the Chinese currency's value. The yuan has risen about 9.4% since July, 2005, according to Bloomberg data. No doubt Beijing will be serving up more policy tweaks in short order, all aimed at reining in its roaring economy.