Since China reported a 11.3% GDP growth in the second quarter and given recent GDP growth upgrades from the World Bank to 10.4% this year and 9.3% for 2007, there was lots of speculation on how China was going to respond in order to prevent runaway growth and inflation.
As readers of my column know, China has increasingly felt global pressure, especially from the United States and the European Union, to let its yuan increase in value in relation to the country’s growth. Not willing to give in to the pressure but at the same time realizing something had to be done, China had raised its interest rates marginally and last week suggested more were coming.
So it was a surprise to hear that recently, the Chinese central bank increased the one-year benchmark rate by 27 basis points to 6.12% up from 5.85%. The rate increase apparently caught all by surprise as a Bloomberg survey indicated that only seven of 21 economists were expecting the Chinese to increase rates by the end of September. But whether the rate hikes are the start of a new upward trend is still uncertain and will probably depend largely on GDP growth going forward.
China wants to moderate its economic growth and prevent a bubble to form, but at the same time, also realize that it does not want to curtail the economic expansion that has made China a world powerhouse in trade. I believe the Chinese central bank may marginally increase rates.
But for its trading partners, the effect of higher interest rates has been welcomed as the yuan rises in value. This should marginally help the trading with China, albeit I do not believe there will be a major impact at this time as China has such a significant cost advantage in labor and other costs. China’s July trade surplus was a record for the third straight month coming in at $14.6 billion. For 2006, estimates call for China’s trade surplus to grow in excess of 50% compared to the surplus of $101.88 billion in 2005.