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Goldman Sachs Global ECS Asia Research

The People's Bank of China hiked benchmark interest rates by 25 bp, rate hike cycle coming close to an end

April 5, 2011

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The People's Bank of China (PBOC) announced on April 5 that the 1-year benchmark lending and deposit rates would be hiked by 25 bp to 6.31 % p.a. and 3.25% p.a. respectively, to be effective April 6. The PBOC also raised the demand deposit rate to 0.5% p.a. from 0.4% p.a. It is common for the PBOC to make rate adjustments at the end of official holidays (the country has been on a 3-day Qingming/Tomb Sweeping holiday since Sunday. The last rate hike occurred on February 8 which was the last day of the Lunar New Year holidays). We believe the hike leaves the interest rate differential for commercial banks largely unchanged, which is a typical practice for the PBOC.

We believe several factors probably contributed to the decision: 1) yoy CPI inflation is expected to remain at elevated levels at least in 1H2011. In particular, March yoy CPI inflation is widely expected to reach the recent new high of 5.1% (reached in November 2010) or higher; 2) rising oil prices is perceived to be adding further imported inflationary pressures; 3) property prices continued to rise in February, despite the tightening policies the government started to implement on the sector since January; 4) there have been a few occasional cases of panic buying of daily household items ahead of the  rumoured price hikes (these hikes were eventually stopped by the National Development and Reform Commission), which seem to suggest inflationary expectations probably remain relatively high; and 5) real economic growth seems to be holding up fine at least up to now which makes senior policy makers at the State Council more willing to allow the PBOC to continue to tighten.

We believe the magnitude of the overall policy tightening package since the start of the year has been large enough to cool down aggregate demand growth sufficiently to lower underlying inflationary pressures. This tightening package includes 1) monetary tightening (mainly in the form of quantitative controls on bank lending); 2) fiscal tightening as reflected in the rapid rise in fiscal deposits which was Rmb291 billion more than the increase during the first two months of 2010. The tightening was driven by very strong growth of fiscal revenue which was 36% yoy during the January-February period. The Ministry of Finance still has not released fiscal expenditure data but judging from the change in fiscal deposits, its growth was likely to be slower than that of fiscal revenue growth; and 3) other administrative tightening measures on the property and automobile sectors (in the form of restrictions to purchase). Given the nature of the most of the tightening measures tend to be administratively and quantitatively based, price-based tools which include interest rate hikes and currency appreciation should be welcomed as we believe they tend to be more efficient in resource allocation. Having said that, we believe the 25-bp hike is more a signaling tool than anything else because of its small magnitude.

Going forward, we expect the government to broadly maintain its tightening policy stance in 1H2011 given the expected elevated yoy CPI, though there might be some subtle adjustments as underlying inflationary pressures come off. Specifically, we expect the government to 1) hike interest rates one more time (with more risks on the downside, i.e., no more hike, than upside, i.e., two hikes or more, given our expectations that sequential inflation will likely to soften). 2) Hike the reserve requirement ratio as a regular tool to manage interbank liquidity; 3) allow further currency appreciation (despite the deficit in the first two months of the year which we think was at least partially seasonal and will disappear going into 2Q2011); 4) maintain a relatively tight quantitative control on bank lending, and 5) maintain administrative controls on the property sector. On the other hand, the effective tightening in fiscal policy might see some adjustments as new fixed asset investment projects kick off. This package should be sufficient to control underlying inflationary pressures going forward and the combination of lower sequential inflation and a higher base in 2H2011 should lead to a meaningful fall in yoy CPI which should allow the government to loosen policy again. However, if the government continues with the full scale tightening as it did in 1Q2011, the economy will be at increasing risks of over-tightening, in our view.


Exhibit 1: Deposit and lending rates

Source: PBOC, GS Global ECS Research.

Yu Song <mailto:Yu.Song@gs.com>
Helen Qiao <mailto:Helen.Qiao@gs.com>

For Goldman Sachs economic data and forecasts please visit Goldman 360 <https://360.gs.com/gs/portal/research/econ/erwin/erwinforecasts/>


We, Helen (Hong) Qiao and Yu Song, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm's business or client relationships.
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