China's central bank raised interest rates Thursday for the first time in nearly a decade, signaling a deep unease with the breakneck pace of development and an intent to curb a construction boom that is sowing fears of runaway inflation.
The unexpected announcement by the People's Bank of China drove down oil and commodity prices, as well as the stocks of mining and metals companies worldwide, with the expectation that China's voracious appetite for raw materials will wane as its economy tightens.
The bank yesterday raised its one-year lending rate by 0.27 percentage points, to 5.58 percent, effective Friday, while rates paid to depositors in Chinese banks would go up by an equal margin, to 2.25 percent.
By itself, the increase amounts to a trifle, a marginal bump that economists said would have little if any immediate impact on the overall economy, now growing at more than 9 percent a year. But analysts construed the announcement as a clear signal that China's leaders are intensifying efforts to cool the economy when a surfeit of new factories, office towers and residential development has outstripped the supply of raw materials and energy. Some expect more increases in coming months as the central bank seeks to slow new investment.
"This is the beginning of a long tightening process," said Dong Tao, China economist at Credit Suisse First Boston in Hong Kong. "The economy must be slowed because it's currently running at an unsustainable level."
U.S. officials praised the interest-rate increase as a sign that China is relying more on market forces to guide its economy and may be speeding a plan to let its currency move more freely against the dollar. China now maintains a fixed exchange rate that U.S. and European officials feel is keeping the cost of its exports artificially low.
"This is a change in the direction of things that [is] very promising -- a more market-oriented financial system, monetary policy and ultimately the flexible exchange rate," John B. Taylor, the Treasury undersecretary for international trade, said in an interview on Bloomberg television.
Only a few years ago, the movement of interest rates inside this still nominally communist country was of little consequence to the rest of the world. But China is now by some measures the world's second-largest economy. Its growth has fueled a surge in demand felt from the iron-ore mines of Brazil and Australia, the cotton and soybean farms of the U.S. Midwest and the luxury-goods-makers of Europe. China's purchases of materials such as palm oil and rubber are now the single largest source of economic growth in much of Southeast Asia. Its hunger for steel and machinery has played a pivotal role in lifting Japan from years of stagnation. China's thirst for oil -- it is the world's second-largest importer -- is among the key factors driving up the price of that commodity.
Yet even as markets adjusted to the prospect of a China slowdown, economists noted that the increase in interest rates is virtually insignificant in itself.
"The impact on the real economy is going to be as close to zero as anything," said Jonathan Anderson, chief economist at UBS Investment Research in Hong Kong. Anderson said the increase is important as a symbolic gesture aimed at persuading depositors to keep their money in Chinese banks. With interest rates unchanged for years even as inflation climbed past 5 percent, worries have set in that China's savers are pulling their money out of banks to seek better returns in speculative investments such as real estate. The state press has carried reports of a growing black market as companies with cash to spare lend it to private entrepreneurs at higher rates of interest than banks are allowed to charge.
Central bank officials have also openly fretted about the prospect of an overheating economy -- growth so fast that it leads to high inflation. In recent months, the government has been trying to gradually ease growth and avoid a so-called hard landing, a sharp drop that could close businesses and throw people out of work.
The root of the problem is visible in any Chinese city. As construction cranes dominate the horizon, the price of everything needed to fashion an office tower continues to climb.
Shortages and bottlenecks abound. Ships wait weeks to unload at overcrowded ports. Rail and road links are overwhelmed. In most of the country, electricity is in short supply and being rationed, forcing factories to limit production.
With so much new money cycling through the system and urban incomes rising, prices of meat and vegetables have leapt -- a boon to farmers whose incomes have long stagnated, but a source of worry that China's poorest people are suffering.
Concern mounts that if real estate prices unravel during a building glut, the banks that have lent in support of the speculative frenzy will be saddled with billions of dollars in bad loans, adding to a tally now estimated by private economists to be about $500 billion.
As such worries intensified earlier this year, China's leaders sought to tame growth through administrative fiat. They imposed curbs on new loans into the hottest sectors of the economy -- in particular, steel, cement and auto manufacturing.
But while those measures have had some effect, inflation has continued to climb. In its statement, the central bank declared that the administrative curbs had "achieved good results," but that a rate increase was required "to address recent conflicts and problems, and to further consolidate the results achieved."
The last time China raised its benchmark lending rate, in July 1995, growth slowed by nearly half, plunging to 7.1 percent in 1999 from nearly 13 percent in 1994.
One economist, Larry Lang, chairman of the finance department at Chinese University of Hong Kong, said the increase was misguided. The largest borrowers in China have traditionally been local governments spending money on major public-works projects, and state-owned firms kept alive to preserve jobs, he said. If interest rates are higher, those sorts of borrowers will continue to draw credit, regardless of their ability to repay their loans, Lang said. Meanwhile, China's emerging private sector, increasingly the source of new jobs and profitable businesses, will have a more difficult time getting its hands on credit.
"This is a very stupid move," Lang said. "It won't affect over-investment, but it will hurt the private sector and it will hit the stock market."
Others were skeptical that the rate increase has any broader effect on issues such as the exchange rate. Nicholas Lardy, a China specialist at the Institute for International Economics, noted that Beijing has lowered interest rates several times over the past few years without changing its currency policy. "This time could be different, but I think the idea that this move somehow presages something on the exchange rate is putting the best possible interpretation on it," Lardy said.