BEIJING (AFP) - China has decided to raise its benchmark one-year lending rate to 5.58 percent from 5.31 percent with effect, the first such move in nearly a decade, the central bank said.
"It's the turn of the interest rate cycle in China," said Andy Xie, Hong Kong-based chief Asia economist with Morgan Stanley.
"Rates have been going down for nine years and now they'll start rising again," he said.
The move follows widespread speculation that China would be forced to take this step, especially after inflation rose above five percent which effectively put real interest rates near zero.
The one-year deposit rate was increased, also by 27 basis points, to 2.25 percent, according to a central bank statement posted on its website.
The central bank has not raised the lending rate in the local currency since 1995.
The government has been struggling since late last year to cool an economy that has seemed close to overheating, creating bottlenecks in energy and transportation.
"This interest rate adjustment is to consolidate the results of macro-economic adjustment," the People's Bank of China said in a statement.
China's attempts at bringing the economy down from its dizzying heights have had limited success so far.
For the three months to September, the economy grew 9.1 percent compared with a year earlier, after 9.8 percent in the first quarter and 9.6 percent in the second, the National Bureau of Statistics said last week.
Policymakers have been particularly worried about frantic growth of investment in sectors such as auto making, steel and real estate.
Investment in fixed assets grew 27.7 percent in the first nine months of the year, down only slightly from 28.6 percent in the first half, suggesting to some analysts that more needed to be done to curb activity.
Overseas financial markets immediately responded to the Chinese rate move, with the dollar rising briefly across the board.
"This reduces the long term risks of an economic recession in China and, more broadly, the world economy," said Audrey Childe-Freeman, an economist at Canadian Imperial Bank of Commerce.
Initial Chinese comments suggested that the rate rise might have a palpable effect on the local economy.
"The Chinese capital markets are not very well developed yet and only a small number of enterprise raise finances directly via stocks," the Sohu.com website said in a commentary.
"The majority of local enterprises still rely on financing from the banks and the rate hike will have a relatively big impact on their cost of capital," it said.
Some analysts, however, have argued that interest rate adjustments are a less efficient tool in China than in more developed economies.
This is because much bank lending is allocated by administrative fiat rather than based on who can service their debts.
"It'll work at the margin and economics is all about at the margin," Citigroup economist Huang Yiping said. "It sends an important policy message to the market."
But given the enormous challenge of slowing the pace of Asia's second-largest economy, analysts said China was all but certain to raise rates further in the not-too-distant future.
"They'll have to," said Chen Xingdong, chief China economist with BNP Paribas Peregrine Securities in Beijing, adding it would probably happen in the first half of next year.
The move to raise interest rates could put further pressure on the government to abandon the yuan's peg to the dollar.
With the fixed exchange rate, policymakers are forced to convert incoming foreign funds into the local currency, pumping up the economy with new liquidity.
Now that the interest rate level has gone up in China, it could attract further capital inflows via official and unofficial channels, making the economy even more flush with money unless the peg is loosened, analysts said.
"It will be a problem, a challenge for the government," said Chen. "Interest rate policy has to be conducted in good coordination with exchange rate policy."
10/28/2004 - 15:27 GMT - AFP