Hot money fears to limit China rate increases

China will steer clear of an aggressive increase of benchmark interest rates because higher rates will only attract additional hot money inflows, a senior government researcher told the Reuters China Investment Summit.

Chen Dongqi, a senior researcher under the powerful National Development and Reform Commission (NDRC), also said that Beijing should not raise its inflation target for 2011 from the current 3 percent level, despite evidence of rising prices.

"Many economists have argued that the inflation warning line should be increased to 4 percent, or even 4.5 percent. But from a macro-economic policy perspective, it should not be increased," said Chen, who is one of the leading architects of the country's economic policies.

His comments, in an interview with Reuters in Beijing, squared with the growing view that China will proceed with only a gradual policy tightening, even though the country's top leadership concluded its annual economic work conference with a strong pledge to combat inflation.

On interest rates, Chen said: "If there were no external factors, China would definitely have to increase interest rates as quickly as possible," he said.

"But if the external factor, by which I mean hot money, has a big role to play, you can't raise interest rates too early or too aggressively as it could intensify expectations of a stronger yuan and lure more capital inflows," Chen added.

Economists polled by Reuters forecast that the People's Bank of China would raise rates before the end of 2010 and twice again in 2011 as part of a campaign to control inflation.

Chen said the central bank had to look at the Federal Reserve in making rate decisions.

"If the Fed does not go for further easing, or if the Fed raises rates in late 2011, then China can move aggressively on interest rates," he said.

INFLATION CONTROLLABLE

Chen, vice president of the Institute of Macroeconomic Research, said China's inflation would be slightly higher next year than the 3.3 percent full-year average he expected for 2010, but would remain under control.

"In the first half of 2011, CPI growth momentum will not be as strong as in the third and fourth quarter this year," he said.

With inflation speeding to a 28-month high of 5.1 percent in the year to November, it has become a pressing concern, but maintaining economic growth remains an equally important policy aim, Chen said.

"We want both stable growth and prices, and we won't give up one for the other," he said.

Chen said China's gross domestic product may grow 10.2 percent in 2010 and another 10 percent in 2011.

He said he was optimistic about the country's growth prospects as per capita GDP reaches a threshold of $4,000, which historically has proved a launching point for consumption in other countries.

Rapid urbanization was creating strong demand for housing, automobiles and home appliances, he said.

He said China would maintain yearly GDP growth of 8.5-9.0 percent in the coming decade, with annual inflation a modest 3 percent.

"As 1.3 billion people dream to get on wheels, China is unleashing an unprecedented car boom," Chen said, giving an example.

(Additional reporting by Simon Rabinovitch)