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CICC report: tightening measures likely in Q2

By Li Zengxin (chinadaily.com.cn)
Updated: 2007-04-30 15:16

On the other hand, higher interest rates may contribute to control asset price bubbles and prevent hot money from flooding in. Ha and his fellow associates believe that higher interest rates can lower corporate earnings growth and property investment returns, controlling low-return investment. Then increased opportunity cost and funding cost will reduce the investment-driven demand for assets.

Unlike conventional wisdom, CICC economists found, there is no significant correlation between interest rates in China and the influx of hot money. Instead, they saw an inverse relationship between the two -- the higher the China-US interest rate spread, the more hot money flows into China.

Ha and his fellow analysts believe the interest rate could be an effective monetary tool to curb excessive liquidity. It is only the inflexibility of the exchange rate that has resulted in the minimal effectiveness of China's monetary policy. RMB appreciation can ultimately strengthen the effectiveness though. The researchers predict a higher speed of appreciation of the RMB this year, likely at 5.9 percent to 7.35 yuan per US dollar at then end of this year.

Moreover, the establishment of the State forex investment company and the expansion of the qualified domestic institutional investor scheme will allow more foreign exchanges held either by the State or Chinese citizens to be invested in overseas equity markets, thus releasing the pressure from the accumulating forex reserves. This will eventually reduce the likelihood of inflation and an over-heated economy.