ôIt makes you wonder who actually controls economic activity in the country,ö says one banker.
One lesson is that despite ChinaÆs successful insulation from the subprime debacle in the US, its economic system faces its own special problems.
The interest rate hike announced on Tuesday pushes the cost of the one-year lending rate up 0.18 percentage points to 7.02% û the fourth rate increase this year, and one which will probably be equally ineffective.
Chinese bankers are already talking about a fifth rate hike in October. ôAdministrative measures have clearly failed,ö says Erwin Sanft, BNP ParibasÆs head of China and Hong Kong equities research, ôso the government is turning to market-based measures instead. This rise comes very soon after the last one.ö
Administrative measures tend to have a short-term impact only, adds Sanft. Such measures include insisting on central government approval in real estate, cement and steel projects. But with growth coming in at 12% in the second quarter and huge stock and property bubbles, they have not been especially effective.
ThatÆs partly because every businessman and official in China knows how to get around the rules, say local sources.
Sanft also points out that the central government is faced by a rapidly growing privatisation of the economy: ôThe government only controls 9% of direct investment, substantially cutting down its scope for intervention. And 50% of the economy is now in private hands, (players) who rely on the informal banking sector anyway.ö
The informal banking sector in China has played a major role in helping finance the growth of small- to medium-enterprises, which tend to be completely cut off from the state banks.
Loan growth in the formal sector is also exploding. But ironically, the fact that the four state banks are now listed on respectable exchanges means that administrative measures for restricting loans are less effective.
Stephen Green, Standard CharteredÆs China economist, believes the rate hike is part of a policy of æmanaging expectationsÆ on inflation û and that it will have an impact, if only indirectly.
Green believes that the central bank could be responding to the debate in China about inflation. The official figures imply there is nothing to worry about: CPI comes in at 5.6%, but drops to just 0.9% with food prices pushed out. Food inflation boils down to pork, where supply has been affected mainly by disease.
These figures donÆt wash with the majority of the population, who see rising costs in many household items. One of the most striking is the 50% rise in the cover price of Caijing magazine, which recently changed from Rmb10 to Rmb15.
ôThe rate hike per se may not have much impact,ö admits Green. "But controlling inflation is also about managing expectation. In that sense, the series of rate hikes this year will help reassure people that the country is not stuck in an inflationary spiral.ö
But reassuring the population with a policy response is one thing. Actually having policies which the government can impose across every constituency is another.
Last year, an influential article came out in the Chinese press wondering whether the central governmentÆs remit extended beyond Zhongnanhai, the leadership compound in Beijing.
David Zweig, a political scientist specialising in China at the University of Science and Technology in Hong Kong, doesnÆt fully agree with such a radical viewpoint. ôThe Chinese government can use administrative tools to impose its will, primarily through personnel.ö
Zweig says that the Chinese government controls 30% of employment in China. And when locked in a power struggle, the current government has been able to push through its views, as when it fired the Shanghai Party secretary earlier this year. But this is hardly practical on a day-to-day basis.
Zweig also notes that the tax reforms in 1994 improved the central governmentÆs financial position considerably, making it less dependent on remittances from the provincial governments.
ItÆs not as if powerful provincial lobbies are the only factor frustrating the government. On the monetary side, too, the government is facing the problem of maintaining an undervalued renminbi just as inflation seemingly requires higher rates. With the US seemingly on the verge of lowering rates, just as China raises them, the country will be bracing itself for renewed inflows of hot money.