Source: The Financial Times                   Date: 11 April, 2011

China this week raised interest rates for a fourth time in five months as it struggles to reduce bank lending, rein in inflation and slow economic growth. The central bank said the official one-year lending and deposit rates would be increased by 25 basis points from Wednesday, raising the deposit rate to 3.25 per cent and the lending rate to 6.31 per cent.

Analysts said the increase came earlier than many anticipated and suggested that price rises for March, to be published next week, were probably higher than expected. Consumer price inflation in China rose 4.9 per cent in February from a year earlier, the same as in January. But politically sensitive food prices accelerated and producer prices increased 7.2 per cent, their most since October 2008. Even after the latest rise in official rates, the return on bank deposits in China is deeply negative once adjusted for inflation. Beijing has made fighting inflation its priority, amid fears that runaway price rises could lead to social instability in the one-party state, as they often have in the past.

“Inflation is like a tiger: once it is set free it is very difficult to put it back in its cage,” Mr. Wen Jiabao, the Chinese premier, told reporters last month. The government predicts that headline inflation will continue to rise and peak around June or July. But official economists made the same forecast at the start of last year and were proved wrong.

An overabundance of bank credit resulting from the government’s post-crisis economic stimulus package is the main cause of inflation, although officials also blamed “external factors” such as soaring oil prices.

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As well as raising rates, Beijing has also increased the proportion of deposits that banks must hold in reserve with the central bank nine times since the start of last year in an attempt to limit the amount they can lend. Large banks in China are now subject to required reserve ratios of at least 20 per cent.

Analysts remain divided on whether China’s economy is slowing or if more concerted action is needed to avoid overheating and runaway inflation. The Chinese economy grew 10.3 per cent last year and Beijing has announced plans to bring the headline rate down while trying to encourage more balanced and sustainable growth.