VZCZCXRO7876
PP RUEHCN RUEHGH
DE RUEHBJ #8109/01 1180951
ZNR UUUUU ZZH
P 280951Z APR 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 4172
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 008109 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
USDOC FOR DAS LEVINE AND ITA/MAC/AP/MCQUEEN 
TREASURY FOR OASIA/ISA KOEPKE AND DOHNER 
STATE PASS CEA FOR BLOCK 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN 
FRANCISCO FRB FOR CURRAN; NEW YORK FRB FOR DAGES/CLARK 
STATE PASS USTR STRATFORD/WINTER/MCCARTIN 
 
E.O. 12958: N/A 
TAGS: EFIN EINV CH
SUBJECT:  China Raises Interest Rates to Rein in Overheated 
Growth 
 
(U) This report is sensitive but unclassified.  Please 
handle accordingly. 
 
¶1.  (SBU) Summary:  On April 27, the People's Bank of China 
(PBOC) announced an increase in loan interest rates, with 
rates on the benchmark one-year lending rate rising by 27 
basis points to 5.85 percent.  Local observers interpret 
this move as a response to fears that the economy is 
overheating.  Statements by government officials indicate 
concerns over excessive investment and overcapacity. 
Although the increase in lending rates is modest, it sends 
a positive signal that the government is using market-based 
instruments to rein in lending.  If this interest rate hike 
fails to have the desired effect, the government could take 
further steps, such as more rate hikes or an increase in 
reserve requirements.  End summary. 
 
Rates Up 
-------- 
 
¶2.  (U) The People's Bank of China (PBOC) announced on 
Thursday, April 27, that effective Friday, the benchmark 
for one-year lending rates will rise to 5.85% from 5.58%, 
and deposit rates remain unchanged.  According to the 
central bank, "The increase in the lending rate is aimed at 
further strengthening the fruits of macro controls and 
keeping solid momentum for the economy to grow in a 
continuous, rapid, coordinated and healthy manner."  The 
PBOC also increased the six-month lending rate to 5.40% 
from 5.22%, and on loans of three to five years to 6.12% 
from 5.85%.  Interest on loans of more than five years was 
raised to 6.39% from 6.12%.  The PBOC last raised the 
lending rates in October 2004.  Furthermore, the central 
bank posted a notice on its Web site quoting DeputyQernor Wu Xiaoling telling a meeting of executives of 
commercial banQnd policy banks that credit controls are 
needed.  "We must strictly control loans to sectors that 
are overheating.  We must ensure control of credit and 
prevent sharp swings in credit growth," she stated. 
 
Overheating Fears 
----------------- 
 
¶3.  (SBU) This policy move is being viewed as a reflection 
of growing concern among China's top leaders over 
overheating in the economy.  In the first quarter of this 
year, Chinese economic growth accelerated to 10.2% on an 
annualized basis and fixed-asset investment growth rose to 
27.7%, fueled by excess liquidity in the financial system. 
Referring to this situation, Chinese President Hu Jintao 
noted in early April that "We do not want, nor are we 
pursuing, excessively rapid economic growth."  The National 
Development and Reform Commission (NDRC) warned on Tuesday 
that annual demand for cement was 1.05 billion tons, while 
production capacity had reached 1.3 billion tons.  Three- 
fifths of the capacity, moreover, was for low-quality 
cement that China's increasingly advanced economy no longer 
needs.  In its notice, the NDRC called for local 
governments to limit new projects in a range of industries 
facing overcapacity, including cement, aluminum, autos, and 
textiles. 
 
A Positive Signal 
----------------- 
 
¶4.  (SBU) In a research report Stephen Green of Standard 
Chartered Bank in Shanghai suggested the PBOC is trying to 
send a strong signal that the authorities are serious when 
it comes to controlling overheating in the economy and 
over-investment.  Econoffs' contacts agree that the Chinese 
Government is likely to follow up with further cooling 
measures to drain liquidity out of the banking system such 
as raising reserve requirements.   Chris Murck, APCO Asia 
CEO and Bank of Shanghai board member, doubted the interest 
rate move would have much impact on the exchange rate.  He 
pointed out that ordinarily high interest rates boost 
currencies, but the PBOC did not change bank deposit rates. 
By raising lending rates while leaving deposit rates 
untouched, the government will allow banks to widen their 
profit margins, which will help cover losses on loan 
defaults, according to Murck.  He noted that low deposit 
rates also encourage domestic demand, another government 
 
BEIJING 00008109  002 OF 002 
 
 
goal. 
 
¶5.  (SBU) Michael Ipson, the banking specialist at IFC's 
Beijing office, saw the interest rate hike as a signal that 
China is more committed to using market-based tools to 
manage the economy, and believes interest rates could 
increase further.  He noted that banks continue to 
underprice loans and this move will help encourage banks to 
lend at more appropriate rates.  In his view, if the 
interest rate hike and PBOC jawboning fail to cool 
excessive lending, the central government will take 
additional measures, including an increase in reserve 
requirements. 
 
Administrative Controls? 
------------------------ 
 
¶6.  (SBU) Professor of Economics Zhao Xijun of Renmin 
University suggested the hike is too small to have much 
impact on lending decisions.  "The move is incremental at 
most, and it did not work to slow investment last time when 
the central bank raised interest rates back in 2004," Zhao 
noted.  He expects, however, regulators will shortly pass 
instructions to managers of large state-owned banks to lend 
less.  Ipson of IFC believes the Government will only use 
administrative controls as a last resort. 
 
Comment 
------- 
 
¶7.  (SBU) Although the 27 basis point interest rate hike is 
modest, it signals that China increasingly is willing to 
allow markets play a greater role in shaping the economy, 
although directives from the central government may still 
play a prominent role.  The adjustment also reflects a 
greater sophistication of financial policymaking in line 
with China?s new status as the world's fourth-largest 
economy.  In the past, Chinese officials have turned 
instinctively to bureaucratic measures to restrain growth, 
before utilizing market-oriented instruments such as 
interest rates. 
 
Sedney