In These New Times

China’s tight control of its currency allows it to raise interest rates without drawing a wave of hot money into local assets. For Asian countries already struggling to cope with the inflow of overseas funds seeking higher returns than the developed world offers, any response to China’s move might take the form of capital controls rather than rate increases, HSBC’s Mr. Neumann said.

The flood of quantitively eased dollars overseas is the issue of the moment and needs a rapid response if emerging economies are not to be  laid waste by this scorched earth policy. China already has the controls in place, the rest must follow its example.

Asia News

20th October, 2010

China’s surprise interest-rate increase is unlikely to elicit copycat moves elsewhere in Asia, but it could accelerate capital controls in the more export-dependent Asian economies, analysts say.

Tuesday evening’s announcement by the People’s Bank of China threw global markets into a tizzy and sparked a widespread shift toward safer assets like government bonds by investors concerned that one of the main engines of the global economic recovery was being throttled down.

But the timing—barely 36 hours before China releases third-quarter gross domestic product data–might also indicate growth is so strong that China feels it can raise rates without risking a meaningful slowdown.

“Chinese policy makers are quite risk-averse, and the fact that they’re raising interest rates is a signal that they’re quite confident that growth is stable in China,” said Frederic Neumann, co-head of Asian economic research at HSBC bank. Thursday’s GDP release “might actually show that China’s economy expanded faster than expected,” he said.

That would ease concerns in Asian countries that depend on Chinese purchases of their exports.

The Bank of Korea said Wednesday it wasn’t yet clear how China’s move would affect the South Korean economy, but that it would be an important factor in its own deliberations. The Korean central bank held rates steady for a third straight month at its policy meeting last week.

“China is Korea’s largest export destination and its policy decision, undoubtedly, affects our own economic conditions and policy moves,” one BOK official told Dow Jones Newswires, adding, “This doesn’t necessarily mean that we’ll follow suit and do the same as early as next month. We need to look into it further to gauge what’s behind China action.”

China’s tight control of its currency allows it to raise interest rates without drawing a wave of hot money into local assets. For Asian countries already struggling to cope with the inflow of overseas funds seeking higher returns than the developed world offers, any response to China’s move might take the form of capital controls rather than rate increases, HSBC’s Mr. Neumann said.

China’s increase “may raise pressure at the margins for these central banks to do something as well, but probably not via the interest-rate route,” he said. The most likely candidates, Mr. Neumann said, are highly export-dependent countries such as South Korea.

Thailand earlier this month reimposed a 15% withholding tax on foreigners’ gains from government-related bonds, and Korean officials have said they’re willing to consider similar measures. Indonesia and Taiwan also have taken administrative steps over the past year to control the inflow of funds.

Officials from across the region were quick to say Thursday that they didn’t anticipate a major impact from the Chinese rate increase.

Bank Indonesia’s Deputy Governor Budi Mulya, for example, told Dow Jones Newswires, “The Chinese economy will likely continue to grow strongly, so that our exports to China, especially coal exports, will unlikely be affected much,”

The Bank of Thailand, with a scheduled meeting Wednesday, was the first to show its hand after China’s move. As most economists expected, it held its benchmark interest rate steady, pausing in its rate normalization efforts amid increasing worries over the baht’s strength, but said the rate cycle remains on an uptrend.

The BOT is under pressure from exporters and the business sector to stay on hold due to the sharp appreciation of the baht recently, but the country’s economic momentum warrants an increase, Standard Chartered Bank (Thai) senior economist Usara Wilaipich said.

“For China, it’s quite clear that they are concerned about asset prices. At some point all Asian central banks will need to care about asset-price pressure,” she said. “If I’m a policymaker I would pay attention to the impact on massive inflows on asset-price inflation, which is building at the moment.”

Any slowing of China’s economy would likely have an outsized impact on Australia, as China is a voracious buyer of coal and iron ore. But Rob Henderson, head of Australian economics atNational Australia Bank, said the Reserve Bank of Australia—which has already raised interest rates by 1.5 percentage points from their post-financial-crisis low — won’t be overly alarmed by China’s increase.

“This is hardly a dramatic move,” he said, following as it does a string of policy moves by China meant to keep its economy from overheating.

Aside from the pending GDP release, another factor influencing China’s timing may have been the meeting later this week of finance ministers from the Group of 20 nations in Gyeongju, South Korea. Chinese officials are certain to get an earful there from their U.S. and European counterparts, who blame a weak yuan for imbalances in the world economy and have been pressing China to let its currency rise more quickly.

For China, a stronger yuan, by reducing the prices of imported goods, would serve to temper inflationary pressures—a goal that can also be accomplished by raising interest rates. Among its other meanings, Tuesday’s increase may have been China’s way of telling the world to forget about any rapid appreciation of its currency.

“You could read it as a signal to the world that China is not prepared to do too much on the currency and is relying on domestic measures to cool down growth,” HSBC’s Mr. Neumann said. “It’s also saying to the world that our growth is so strong that we can afford to raise interest rates even as other economies ease, and we’re doing our bit to sustain global growth. Therefore, from their perspective, criticism of China’s exchange-rate regime is unwarranted.”