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Editorial: Pouring cold water on the economy

As expected, the central bank on Thursday raised its benchmark interest rates 0.125 percentage points, its 11th straight quarterly increase. The bank offered a mild economic outlook and a gentle touch on rising housing prices, but it also hinted that inflation would remain a predominant concern.

Judging from the bank's renewed warnings on inflation, central bank Governor Perng Fai-nan (彭淮南) and his policymaking colleagues seemingly failed to consider rate cuts to stimulate the economy.

The bank appeared unconcerned that the latest hike would pour cold water on the nation's already chilled investment sentiment. Instead, the bank could once again raise its rates at its next policy meeting in June if inflationary pressure -- such as oil prices staying at high levels and real estate prices continuing to increase -- persists.

Perng said on Thursday that interest rates, following the latest adjustment, were getting much closer to the "neutral" level and had not peaked yet. He first began using the term "neutral" in September 2004 when the bank kicked off a series of rate hikes to steer the negative real interest rate back to a rather comfortable level in hopes of neither provoking inflation nor jeopardizing economic growth.

Since then, the bank has ratcheted up its benchmark interest rate by a cumulated 1.5 percent and brought its rediscount rate charged to commercial lenders to a five-year high of 2.875 percent.

Unfortunately, the bank's rate hike effect on money supply has been shrinking and its attempt to push money market rates upwards has been negligible as mid and long-term rates in the market have not followed the bank's two-and-a-half years of tightening measures.

Several commercial lenders announced over the weekend they would only increase short-term interest rates on time deposits and time saving deposits 0.03 percentage points, beginning today. By doing so, they were once again signaling to the market that the prevailing funding conditions are flush with funds but no outlets to lend the money under a slow private investment environment.

No wonder the central bank said on Thursday it would auction long-term negotiable certificates of deposit on a regular basis to help absorb such surplus capital in the market.

As the key interest rate is still one of the lowest in Asia outside Japan -- even after the latest rate increase -- it will continue to weigh on the value of the currency. By maintaining a weak NT dollar, the central bank seems to believe it will continue contributing to export growth and maintain sustainable growth.

The bank's basic stance is that as long as the inflation is under control and the economy is on a stable expansion track, its effort to fine-tune its monetary policy through gradual rate hikes will help sustain this growth.

The problem with this approach, however, is that if the NT remains one of the region's underperformers, investors who used to borrow the local currency at a low interest rate to invest in higher-yielding assets elsewhere will continue to do so in future.

The soft pace of private investment is likely to weigh on an economy that otherwise demands that the government improve the investment environment and increase public expenditure, not just the central bank's monetary policy. Commercial lenders' hesitance to increase mid and long-term rates suggests that inflation is what the central bank can best deal with, while problems of weakening growth momentum are beyond its power to influence.
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