On April 27, China's central bank, the People's Bank of China, announced that the following day it would raise its one-year lending rate by 0.27 percentage points to 5.85 percent from 5.58 percent. This was the first hike since October 18, 2004, but it differed from the 2004 raise in that the deposit rate remained unchanged.
This move by the Chinese government was aimed at tightening controls on lending and preventing investment from rising too rapidly, without lowering consumption levels and attracting more speculative "hot money."
There are indications that the Chinese economy, despite two years of macroeconomic control measures, is still at risk of overheating. During the first quarter of this year, China's GDP and broad money supply, M2, grew by 10.2 percent and 18.8 percent, exceeding the expectations of the Chinese government by 2.2 percent and 2.8 percent.
China's banks have also extended new loans to the tune of 1.26 trillion yuan (US$157 billion) in the first quarter, accounting for more than half of the annual target of 2.5 trillion. In addition, the total investment in fixed assets has reached 1.398 trillion yuan, an increase of 27.7 percent over the same period last year.
The current investment rate is the highest since the Chinese government decided to open up to the rest of the world 27 years ago, and is even higher than the heady years of economic overheating in 1992 and 1993.
To effectively cool down the overheating economy, China's central bank has attempted to raise loan interest rates to increase the cost of capital, to reach the target of putting a lid on investment and suppress rapidly growing credit.
At the same time, it has kept deposit rates unchanged to keep domestic consumption from slackening and stop more hot money from flowing into China.
China's National Development and Reform Commission and the Ministry of Land and Resources recently released guidelines aiming to restrict the use of land and the granting of loans and prevent excessive growth in investments in some industries and regions.
The two agencies also issued guiding principles regarding structural adjustments for the cement, coking, ferro alloy and steel industries.
The inflow of foreign currency caused by the undervalued Chinese currency is a main factor behind the overheating Chinese economy. Since July 21 last year, when the government allowed the yuan to appreciate 2.1 percent against the US dollar, the yuan has only appreciated by another 1.2 percent. This has been insufficient to lower expectations on international markets that the yuan will further appreciate, which has led to continuously growing foreign exchange reserves. In the first quarter of this year, China's foreign exchange reserves increased by US$56.2 billion, US$7 billion more than in the same period last year. In February, China overtook Japan to become the world's biggest holder of foreign exchange reserves.
The excessive amount of foreign exchange is a serious threat to the independence of China's monetary policies and it also poses a great financial risk. Last year, the accumulation of foreign exchange accounted for 62.9 percent of the total increase in base money.
More troubling is that a lot of the foreign exchange flowing into China is international hot money speculating on the appreciation of the yuan.