Beijing Can't Have it Both Ways

MARCH 6, 2011   THE WALL STREET JOURNAL

By TOM ORLIK

China's government wants to fight inflation and redistribute income, giving households a bigger slice of the pie. Higher interest rates would achieve both. That's not, apparently, how Beijing sees it.

Parsing the language in Chinese government communiqués is never easy. But Premier Wen Jiabao's work report, delivered to the National People's Congress on Saturday, certainly didn't suggest that many more increases in rates, already raised three times in the past six months, are likely.

Instead, pride of place goes to "creating a good atmosphere for transforming the pattern of economic development." That suggests the government believes buoyant growth is necessary to cushion the impact of vital but painful reforms to increase the share of domestic consumption in gross domestic product.

At first blush, that makes some sense. More resources for households mean less for the industrial sector, the driver of growth in the Chinese economy for the last 30 years. Hammering industry with higher interest rates could be a recipe for disaster.

But on inflation, it is too early for the government to declare mission accomplished. Higher oil prices, higher wages and a global liquidity glut all suggest that bringing prices under control won't be as simple as releasing a little grain from the reserves.

And while keeping rates low means easy money will keep flowing to business borrowers, it also means household depositors will be kept in the red. With the consumer-price index rising 4.9% year-to-year in January and the one-year deposit rate at 3%, household savers are facing a real interest rate of negative 1.9%. Even if Beijing brings inflation down to 4%, the target for the year, and the central bank takes the deposit rate up to 3.5%, savers will still lose.

China's households are no strangers to financial suffering. In 2010, the real interest rate for savers with one-year fixed-term deposits averaged negative 1.1%. For demand deposits, the real interest rate was negative 2.9%. These negative real interest rates are effectively a tax on China's households, which do most of the saving, and a subsidy to government and business, which do most of the borrowing. Applied to the net level of household deposits, the implicit tax on households last year added up to tens of billions of dollars. That inequity is one of the main causes of the skewed income distribution the government says it wants to address.

By trying to have everything, Beijing risks ending with nothing. Going slow on rate increases might leave the government's targets on inflation and raising the share of household income unmet.