China should raise its benchmark interest rate step by step to prevent economic bubbles, said Zuo Xiaolei, chief economist with Galaxy Securities Company in an article published in China Securities Journal Monday.

China is very cautious about further interest rate hikes, fearing that they will entice more speculative funds into the country and accelerate the formation of economic bubbles.

China deliberately keeps its Renminbi interest rate 3 percentage points below the U.S. dollar rate, in order to maintain a high opportunity cost for overseas capital entering China, Zuo said.

But since investors are convinced that the Renminbi will continue to appreciate, the 3-percentage-point gap will not prevent foreign capital from flowing into China and buying assets in the country, Zuo said.

But raising interest rates step by step will restrain the money supply, help solve the problem of excessive liquidity and reduce the possibility of economic bubbles, she said.

To date the central bank, the People's Bank of China (PBOC), has preferred to raise the deposit reserve ratio -- rather than interest rates -- to fight excess liquidity.

The PBOC announced on Feb. 17 that it would raise the country's required reserve ratio by 50 basis points from Feb. 25, just 40 days after the previous increase, the fifth hike since July 5, 2006.

The rate hike increases the reserve ratio to 10 percent. Rough calculations indicate that the rate increase will siphon about 170 billion yuan of banking funds from the market.

But with the country's trade surplus continuing to widen, the liquidity problem will not go away anytime soon.

Source: Xinhua