In such a time of global financial instability, why might the People’s Bank of China, for the first time in six years, decreased its benchmark lending rate by 27 basis points to 7.2%?
In addition to the more immediate steps the Chinese government is taking to crutch the domestic stock market, mandarin authorities might want to consider the bleaker outlook The Economist has taken towards prospects in emerging markets:
For the past few years, China, Brazil and others, with their high growth rates and large current-account surpluses, began to seem like desirable alternatives to developed markets.
But with increasingly higher risk now associated with emerging markets, capital has fled and new investment has subsided substantially:
In China, worries are growing about weakening export demand (growth in export volumes has fallen by almost half over the past year to 11%) and falling property prices, which seem to play a role similar to equity prices elsewhere. In the past three months, property sales in big cities were 40-50% lower than a year ago, according to figures tracked by Paul Cavey of Macquarie Securities. An agent for one of Hong Kong’s largest property companies says “confidence ended this week with the fall of Lehman.”
Although The Economist stated in a report earlier this year that export demand played little role in GDP growth, compound the aforementioned slump in the property market with remarks from the same earlier report:
China's economy is driven not by exports but by investment, which accounts for over 40% of GDP. This raises an additional concern: that weaker exports could lead to a sharp drop in investment because exporters would need to add less capacity. But Arthur Kroeber at Dragonomics, a Beijing-based research firm, argues that investment is not as closely tied to exports as is often assumed: over half of all investment is in infrastructure and property. Mr Kroeber estimates that only 7% of total investment is directly linked to export production.
Returning to the article at hand, and to answer our original question:
China’s interest-rate cut shows that its government, too, has room for manoeuvre. But the cut will have little direct impact on the economy because lending is limited by quotas. It was intended to boost confidence at a time of falling share and house prices. Too bad that among emerging-market investors, confidence is in short supply.
See the full article here.