Research and analysis

China: more reform than stimulus

Published 28 November 2014

This research and analysis was withdrawn on 1 August 2016

This publication was archived on 1 August 2016

This article is no longer current. Please refer to Overseas Business Risk - China

This publication was archived on 4 July 2016

This article is no longer current. Please refer to Overseas Business Risk - China

Summary

China announces a cut to interest rates on 21 November , its first since 2012. The direct impact is likely to be small. Accompanying measures to support savers, including through further deposit rate liberalisation, are more significant. A (rare) victory for China’s consumers over the commercial banking system, and an illustration of market-orientated reform. Further loosening likely if the authorities judge China’s economic slowdown is proceeding too fast.

Detail

The People’s Bank of China (PBOC) surprised markets late on 21 November by cutting interest rates for the first time since 2012. The asymmetric cut, which reduced the lending rate by 40 basis points and the deposit rate by 25 basis points, was accompanied by a partial liberalisation of deposit rates: as of 24 November commercial banks are able to set deposit rates at 1.2 times the base rate, up from a previous maximum of 1.1 times.

Comment

The authorities have faced increasing pressure to cut rates in recent months as the economy has been slowing. This is despite repeated assurances from the authorities that the economic slowdown is a long term structural trend that cannot be reversed through stimulus policies: as President Xi told APEC leaders earlier this month, “the era of super-fast growth is over and we should adjust to the new normal of medium-to-fast growth”. Calls to loosen policy became more vocal earlier this month with October’s surprisingly weak lending data.

This latests move should not, however, be interpreted as a significant change in polcy. The scale of the cut is small, with base lending rates being cut by less than half a percentage point. In an unusually detailed Q&A issued alongside the cut the PBOC emphasised that monetary policy would “remain stable”, growth “remains in a reasonable range” and “there is no need for strong stimulus”. The PBOC have long been advocating greater financial discipline after the 2008-2012 credit binge..

The short-term impact of the cut will be small, not least because it isn’t clear that interest rates are the most important factor behind subdued credit growth. A reluctance by firms to further increase their leverage is likely to be at least as important, as is banks’ reluctance to lend aggressively in the context of rising levels of bad debt. Credit loosening, for example by reducing the required reserves ratio, would be more effective at addressing the latter two constraints.

But the move is still highly significant. A broad interest rate cut is consistent with efforts to allow markets “a decisive role” in resource allocation, as called for in last November’s Third Plenum. This is in contrast with earlier efforts by the PBOC to introduce more targeted easing, for example through the reduction in rates for rural banks. In addition, the deeper cut to lending rates than deposit rates shows the PBOC wants to protect savers’ incomes and hence private consumption.

Most importantly, banks are now allowed greater flexibility on the deposit rate they can provide, an important step towards full liberalisation. Liberalising interest rates is probably the single most important reform China needs to implement as this determines the allocation of capital around the economy. The lending rate was fully liberalised last year, leaving just the deposit rate. The deposit rate is seen as particularly important because it controls the income China’s prodigious savers receive from their savings and therefore has a bearing on household consumption.

Deposit rate liberalisation will further increase competition for deposits within China’s banking system. This benefits savers at the expense of the banking sector, which is already facing pressure from wealth management products and rapid growth (albeit from a low base) in online money market funds. However, t China’s banks remain among the world’s most profitable (second only to US banks in terms of net interest margins).

Practically all economic policymakers expect growth to continue to slow and it is widely anticipated among both Chinese and foreign commentators that next year’s growth target will be set at 7.0 percent, down from ‘around 7.5 percent’ this year. However, the authorities have always stressed the need for a controlled slowdown. If it looks like activity is starting to slow too fast, further cuts to either interest rates or the required reserve ratio are inevitable.

Disclaimer

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