Roach: China Must Slow Down, and Now

Morgan Stanley Asia Chairman Stephen Roach, normally a critic of U.S. economic policy, has a few choice words for China now.

Roach thinks China should slow down, pronto.

The country’s central bank should raise interest rates by at least 1 percentage point and cut its annual economic growth to 9 percent in order to halt raging inflation, he tells Bloomberg in an interview.

Lower demand for exports led China’s economy to grow by 10.6 percent during the first quarter, slower than the 11.2 percent rate experienced during the prior three months, although still blazing fast for even a small economy, never mind a major country.

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China's economy has averaged 10 percent annual growth and expanded its size 68 times over since 1978, when free-market reforms began.

It could soon overtake Germany as the third-largest economy in the world.

Meanwhile, prices for Chinese consumers rose 8.3 percent in March — close to an 11-year high — driven by escalating food energy costs.

A push for slower growth puts Roach at odds with Chinese officials who believe an economic slowdown of that magnitude would jeopardize the government’s efforts to create jobs and lower poverty.

"You have to make a choice between growth and inflation,” Roach says. "You can’t have both.”

That’s because an inflation rate higher than the prevailing interest rate creates serious problems, Roach warns.

"They are running a negative real interest-rate policy at a time when they are having price shocks, food and energy prices are starting to creep up, and wages are going up,” Roach says.

"History tells you it's a dangerous combination to see wages and prices going up at the rate they are going up now with negative real short-term interest rates.”

China's key one-year lending rate is presently at 7.47 percent, a nine-year high. Its deposit rate is 4.14 percent, less than half the inflation rate.

Roach believes the Chinese government may be following the same erroneous path taken by the U.S. Federal Reserve in the 1970s.

That is, focusing on "core inflation” while ignoring inflationary factors like rising food and energy prices the government believes are temporary.

In a recent research report, he noted that low interest rates in the U.S. provided "a lethal stimulus” to an inflation-prone economy.

"[China’s] central bank needs to act, and it needs to act now,” Roach says. "The longer they defer this the more worrisome it becomes. It raises the risk of a hard landing.”

Though China’s central bank has ordered lenders to set aside larger reserves and has expanded price controls to help cool the country’s overheated economy, interest rates remain unchanged this year following six increases in 2007.

Premier Wen Jiabao appears determined to adhere to a tight monetary policy to avoid attracting inflows of speculative capital that could fuel inflation in an economy that already has too much cash in its financial system.

Chinese statistics bureau official Zheng Jingping has publicly stated that economic growth of less than 9 percent would mean "the tightening is overdone and needs to be loosened.”

According to JPMorgan Chase research head Frank Gong, China could revalue the yuan by 10 percent to 15 percent in the coming months as policymakers seek to control inflation.

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