China tries to cool its economy

China took the global markets by surprise yesterday as it raised interest rates for the first time in nine years in an attempt to cool its rampant economy.

The move - which raised the country's official deposit and lending rates by 0.27 of a point to 5.53% - sent bonds, stocks and the US dollar into turmoil as financial markets tried to digest the implications for the world economy, of which China is rapidly becoming an increasingly important part.

Analysts said the Chinese authorities had probably decided on the move because other measures to rein in credit growth and fixed investment had not been sufficient to cool the economy, which has long been in danger of overheating.

The Chinese government estimates that its economy grew at an annual rate of about 9% in the third quarter of the year, down marginally from the 10% seen in the first quarter but still far more rapidly than any economy in the developed world.

China is growing so fast that it is likely to overtake Britain in 2005 to become the world's fourth largest economy.

Its vastly larger population means its people will take many years to catch up with Britain in terms of income per person, however.

The growth rates have been so dramatic that the prices of world commodities such as copper, steel and oil have been pushed to record highs as the Chinese economy has sucked in vast quantities of materials to feed its hungry factories.

Oil prices hit a record high of $55.67 earlier this week and analysts say surging Chinese demand has been a crucial factor driving up oil this year.

Indeed, oil prices fell back on world markets after the Chinese rate increase on concern that it would cool the country's demand for oil.

In London and New York, the stocks of mining companies, which have benefited from the rapid Chinese expansion, fell sharply as traders feared that demand for other commodities would also be hit if the Chinese economy slowed.

But analysts cautioned against overreacting. "The decision to hike rates by China should not come as a shock. We have just come through a period in which global growth was historically rapid, and China was the strongest component," said Larry Kantor, an analyst at Barclays Capital.

"Moreover, Chinese inflation has picked up. Growth seems to have slowed somewhat since the extraordinarily rapid pace at the start of the year, but clearly not enough to satisfy the Chinese authorities," he added.

The dollar gyrated on the foreign exchanges as the markets tried to assess the significance of the move. The currency, the renminbi, is pegged to the dollar by the Chinese authorities at an artificially low rate of 8.28 to the dollar to boost exports.

Eventually the dollar fell back against the yen and other major currencies as traders decided the rise could be a precursor to a move by the Chinese authorities to revalue its currency.

Tapan Datta, an economist at Schroders, said the rate move was too small by itself to make much difference to the Chinese economy but did signal renewed determination by the Chinese government.

"The bets will be on that further rate rises will come, given that this prolonged policymaking paralysis has been overcome. Worries are going to set in about a tighter policy environment in 2005 and their effects, as they should!"