BANKS in Shanghai have seen a sharp increase of customers wanting to transform their money into fixed deposits since October 29, after the country announced a surprise interest rate increase.

"Encouraged by the new interest rate, more people are shifting their investments to savings and are looking forward to a stable and relatively high return. That's why the banks are crowded, sometimes leading to a wait of more than two hours before being served," said Ye Weijie, a staff member from the Bank of Shanghai.

On October 28, the People's Bank of China, the nation's central bank, raised its benchmark lending and deposit rates for the first time in nine years.

Analysts say the move clearly shows the central government's concern over runaway inflation.

Economists have been expecting the increase since June when China's Consumer Price Index (CPI) exceeded 5 per cent for the first time. In the following months, the CPI inflation rate remained above 5 per cent, which kept China's interest rate structure negative in real terms.

Though the interest rate hike is seen as minor, with a further rise expected, analysts say its impact is far-reaching.

According to a press release from the People's Bank of China, the increase is aimed at "preventing enterprises from excessive borrowing and reducing the external cycle of credit funds."

Economists say the rise will increase the financing costs for enterprises and help banks attract more deposits in order to curb inflation.

Declining property sector

Since the second half of last year, the central government has adopted macro-control measures to slow down investment in some overheated industries.

"So far, these measures have proved to be successful in the steel, concrete and aluminum sectors," said Tang Shuangning, vice- president of the China Banking Regulatory Commission during a recent forum on macro-control and banking regulations.

However, growth in the real estate industry remained vigorous in the first nine months of the year. The prices of commercial and residential buildings increased by 13.4 per cent compared with the same period last year.

It is believed the primary aim of the rate hike is to ease overheated investment in the property sector.

"The interest rate increase will definitely add to real estate developers' financing costs," said Lu Qianfeng, an analyst with FPD Savills, an international network of property professionals providing integrated services to clients through more than 140 offices in Asia. "However, it won't affect developers substantially since the increase is small and developers have already sought other financing channels such as commercial funds."

Liu Shejian, an analyst from the Shanghai Social Science Academy, said: "Since many people buy houses as a way of speculating, the increase may add to their investment costs which may as a result reduce the demand of real estate."

"Consumers may also expect a price drop after the rate increase and hold back their money. If so, the property sector may experience a real slowdown," Liu added.

According to the 21st Business Herald, sales volume in the Shanghai real estate market shrank 30 per cent in the days following the rate increase. In addition, local banks are receiving more and more inquiries from loan takers wishing to increase their downpayments on property loans.

Control of capital inflow

The interest rate rise also sparked discussion about the revaluation of the RMB.

"After the hike, the need to adjust the exchange rate mechanism is becoming more prominent," Ba Shusong, vice- director of the Financial Research Institute of the Development Research Centre (DRC) of The State Council, wrote in an article for the Sina website.

The re-assessment of interest rate and exchange rate of the yuan should go hand in hand with the reform of their formation mechanism, said Ba.

But analysts also pointed out that if the exchange rate is raised against the US dollar, it could spur more capital inflow, including speculative funds.

According to a recent report by the State Administration of Foreign Exchange (SAFE), China's foreign exchange reserve has increased by US$111.3 billion, which is almost the equivalent of last year's entire figure, while China's trade surplus is seeing a decrease.

On November 2, shortly after the rate rise, SAFE announced that it would reinforce the inspection of speculative capital to guarantee the stability of the economy.