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Technically independent

China tightens monetary policy (discreetly)

A small interest-rate rise shows the central bank testing the limits of its independence

Feb 11th 2017

IF ASKED before the start of 2017 to bet on which important central bank would be the first to raise interest rates this year, the safe choice would have been the Federal Reserve. Some gamblers, relishing the long odds, might have gone for the Bank of England or even taken a flutter on the European Central Bank. All these guesses would have been wrong. The first to budge this year? The People’s Bank of China.

On February 3rd the Chinese central bank raised a series of short-term rates. The decision received scant attention. The increases were, after all, small: one-tenth of a percentage point for the main rates. It also seemed quite technical, primarily affecting liquidity tools that lenders can tap if short of cash. And there was no fanfare: the central bank did not publish an explanation.

But China’s move is important for two reasons. First, it highlights the government’s dilemma in managing the economy. Growth is expected to slow from last year’s pace of 6.7%, and recent surveys suggest that momentum is already ebbing. Sentiment is fragile: investment by private companies last year increased at its slowest pace in more than a decade. This would normally not be the time to launch a monetary-tightening cycle. However, other dangers loom. The housing market is frothy. Credit growth has been excessive. And financial institutions have used increasing amounts of debt to buy bonds.

The central bank hopes to strike a balance. By nudging up money-market rates, it wants to push lenders and investors to pare back their borrowing. But it also wants to avoid harming growth.

It is a fine line. Chinese policymakers at least have one advantage over peers in developed economies: they can count on the press to amplify their message. State television said the rate rise would affect financial institutions, but not the public — as if it were somehow possible to segregate one from the other.

This points to the second ramification: the way in which the People’s Bank of China conducts monetary policy is changing. It is beginning to look a little more like central banks in developed economies as it shifts towards liberalised interest rates. Rather than simply ordering banks to set specific lending or deposit rates — the focus for many years in China — it is altering the monetary environment around them. China does not yet have an equivalent of the federal-funds rate in America or the refinancing rate in Europe, but it has a few candidates for its new benchmark interest rate. The seven-day bond-repurchase rate, which influences banks’ funding costs, is in pole position.

There is also an element of political intrigue in this transition to a more mature monetary framework. The Chinese central bank sits under the State Council, or cabinet, which has the final say over lending and deposit rates as well as other big policy decisions. Repo rates, by contrast, are seen as sufficiently abstruse for the central bank to decide on its own when it wants to change them.

In other words, the more technical a policy is, the more technocrats can carve out space for themselves. Yet this also gives the Chinese central bank one more reason to raise rates cautiously. Were its actions to have a bigger impact on the economy, its newfound, if limited, independence would not last long.

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