China’s central bank cut interest rates by a quarter of a percentage point last night to stoke the weakening economy.
The move, seen by economists as China’s strongest measure yet to steer the economy away from a hard landing, sends two important messages. First, as much as Beijing wants to have a healthier and more balanced economy, fast growth remains a priority. Second, policymakers have become confident of liberalising the nation’s tightly controlled interest rate regime.
The cut came less than 48 hours ahead of China’s May macroeconomic data releases this Saturday, suggesting China’s economic thermometers, including fixed asset investment and industrial production, might have deteriorated further during the past month, pushing overall economic growth below the government’s tolerance level.
More significantly, the People’s Bank of China (PBoC) said that the country’s commercial banks would be allowed to set deposit rates 10% above the benchmark level and to set lending rates 20% below the benchmark.
The new rules say that “the time is ripe for a further push of interest-rate liberalisation, in addition to the opening of capital accounts and renminbi exchange rate system reform”, wrote Qu Hongbin, a China economist at HSBC, on his blog after PBoC’s announcement. “China is well placed for a thorough financial reform.”
Zhou Xiaochuan, the central bank governor, has publicly noted that conditions are “basically ripe” for setting market-based interest rates. Some specialists warn that freeing interest rates will lead to overly aggressive competition for deposits and force smaller banks to collapse — though the state-directed rate system has caused public anger for decades, squeezing the nation’s penny-wise savers, shovelling cheap capital to government-backed companies and at the same time ensuring the big lenders’ profitability.
HSBC’s Qu estimates the skewed interest rates offered by China’s banks have contributed a staggering Rmb1.5 trillion ($225 billion) to their coffers.
The central bank announced on its website last night that it will lower the one-year benchmark lending rate to 6.31% from 6.56%, and the one-year deposit rate to 3.25% from 3.5%, effective June 8.
“On the surface, it seems like a balanced cut, but since the banks could make the most of the flexibility, it is actually an unbalanced rate cut,” said Jun Ma, a China economist at Deutsche Bank.
This cut comes several weeks after a cut of 50bp to reserve requirements and after several consecutive months of weak macroeconomic data.
“The latest rate cut is in line with our expectations, following several months of weak macroeconomic data highlighted by particularly weak April data, and with May data also likely to be uninspiring,” said Hu Yifan, chief economist of Haitong International Securities.
“We expect two to three additional RRR cuts to come for the rest of the year; and one to two further interest rate cuts are possible, depending on the balance between growth and inflation during the coming months,” she said.
Yifan expects more supportive fiscal policy measures such as an energy-efficient household appliance subsidy will be announced in the near future, primarily supporting consumption and infrastructure projects.
One has to admit the rate cut is aggressive, but will it encourage Chinese people to save less and for companies to borrow more? Probably not.