China's immunity from global turmoil

Rate hike reflects China's immunity from global turmoi 2007-8-22

BEIJING (XFN-ASIA) - China's bid to tighten liquidity while most central banks worldwide are battling to boost cash flows underlines the Asian giant's status as largely immune from the troubles afflicting global markets. The financial insulation, highlighted in a decision to raise interest rates again, is an arrangement of China's own making, as it combines a not fully convertible currency with limited access to the capital markets. ""Fundamentally speaking, the impact the global economy has on China is much, much smaller than on other Asian economies,"" said Ma Jun, a Hong Kong-based economist with Deutsche Bank. Worries about problems in the US mortgage market have caused liquidity to dry up in money markets as private banks withhold funds, prompting US and other central banks to offer extra cash. China is doing the opposite, sucking up as much cash as possible in an only partly successful attempt to prevent it flooding into stocks and property. ""China's central bank is not concerned about the global financial market havoc creeping into the domestic market,"" said Stephen Green, a Shanghai-based economist with Standard Chartered. ""China is still a different universe it seems when it comes to liquidity and growth momentum."" China's central bank raised the benchmark lending rate by 0.18 percentage point to 7.02 pct Tuesday, while the deposit rate was hiked by 0.27 percentage point to 3.60 pct. This was the latest chapter in China's prolonged struggle with excess liquidity, boosted directly by foreign fund inflows under the current exchange rate regime. ""The high level of liquidity is mainly from our large trade surplus plus incoming foreign direct investment,"" said Feng Yuming, a Shanghai-based economist with Orient Securities. ""In addition, there's a great deal of hot money, although it's tough to estimate exactly how much."" The surprise interest rate hike, which is the fourth this year, suggested a more hawkish central bank than many had expected. It also served as a message to local markets about the continued independence of Chinese economic policy-making. ""It's also a signal to the domestic market: Even at a time of a liquidity crunch overseas, China will not change its policy of tightening,"" said Sun Lijian, an economist at Shanghai's Fudan University. But it will not be without risks, especially given the fact that it takes place at the same time as the United States is lowering interest rates. ""It will strengthen the pressure for the Chinese currency to rise, and even more money will flow into China,"" said Han Zhiguo of Beijing Banghe Fortune Research. ""This, in turn, will greatly boost liquidity and heighten inflationary pressures,"" he said. It would seem as a never-ending story, as the policy response might be more rate hikes, which in turn, would encourage fund inflows, and so on. Little by little, however, China is opening up for greater integration with overseas financial markets. This is reflected in a move this week to allow one bank branch in north China's Tianjin city to offer direct investment in Hong Kong stocks. It could lead to 40 bln hkd flowing to Hong Kong stocks in the coming 12 months, according to Deutsche Bank's Ma. ""But it will be another three to five years before China is heading towards full convertibility, and only then will it be possible to say that it has genuinely linked up with global financial markets,"" he said.