CDT Money: Game On

Under a cloud cover of speculation about a potential fiscal stimulus package, China’s central bank announced a 25 basis point cut to lending and deposit rates on Thursday, its first interest rate cut since late 2008 and the latest measure taken to fend off a hard landing for the economy. Even more significant, it signaled a step down the road of market-based reform for a Chinese banking system that has fueled the country’s economic growth through a model of government-set interest rates.

People’s Bank of China (PBOC) Governor Zhou Xiaochuan wrote back in March that conditions were “basically ripe” for interest rate liberalization, and former PBOC adviser Li Daokui also claimed in a  March speech that banks were big enough to fend for themselves. The policy move suggests, to an extent, that Beijing agrees. Banks now have greater flexibility to set the rates that they offer to savers (up to 1.1x the deposit rate, vs. 1.0x before) and borrowers (as low as 0.8x the lending rate, vs. 0.9x before), which will give households more reasons to put their cash in the bank and will allow banks to offer more attractive terms to potential borrowers.

The Wall Street Journal’s Tom Orlik writes that the policy move “hasn’t come a moment too soon” and will help ease the problems caused by the existing system:

Low interest rates for savers have triggered an exodus of funds from the banking system into new wealth-management products—short-term investments offering some of the security of a deposit but with inflation-beating returns. Assets invested in these products have grown from almost zero a few years ago to equal roughly 10% of deposits in the banks by the end of 2011, according to some estimates. As a consequence, the banks are starved of deposits, making it difficult for them to ratchet up lending to support growth.

Thursday’s move will also help to alleviate a problematic inflexibility on the lending side. In the past, banks could lend at a discount of up to 10% of the benchmark lending rate. But that discount has proved insufficient to attract borrowers, with major customers facing lower returns on investment. Medium and long-term loans to business were down 45% year-to-year in April.

The IMF hailed the adjustment in monetary policy, but not everyone applauded the news. CNBC Market Watch’s Craig Stephens warned that it could do more harm than good, and investors sold off Chinese bank shares on concerns that the rate cut would squeeze profits. Beyond that, attention quickly turned to the weekend and several key pieces of May data scheduled for release. Exports (+15.3%) and imports (+12.7%) both saw strong year-on-year increases, beating expectations and widening China’s trade surplus, though one economist told The Wall Street Journal  “it is doubtful” that the growth could be sustained into the summer due to the economic turbulence in Europe. Most importantly, China’s National Bureau of Statistics announced that consumer prices rose just 3%, a two-year low. Bloomberg reports that the figure should help assuage fears that more loosening will lead to price spikes. While Beijing has battled high inflation in the past year, writes David Pierson of The Los Angeles Times, focus can now shift to buoying the economy.

Still, retail sales grew at their slowest rate since 2011 and factory output continues to hover just above three-year lows. Given that the country faces sub-8% GDP growth in the second quarter and possibly its lowest full-year growth level since 1999, will the door remain open for increased monetary policy support? Economist Ding Shuang told Bloomberg today that he expects up to two more interest rate reductions this year, part of an “aggressive” easing strategy:

The expansion this quarter may be “very weak” at 7 percent to 7.5 percent, Ding said after the government announced data for industrial production, inflation, fixed-asset investment and exports over the past two days. Better-than- forecast trade growth in May may not be sustained as a likely recession in the European Union restrains demand, he said.

The central bank last week cut rates for the first time since 2008 in what Ding said was a “very strong signal of more aggressive policy easing.”

Overseas shipments climbed 15.3 percent in May from a year earlier, the customs bureau said yesterday, exceeding all 29 estimates in a Bloomberg News survey. Industrial output rose by less than 10 percent for a second month and retail sales increased the least in almost six years excluding holiday-month distortions, statistics bureau reports showed June 9.

Any Bulls Out There?

Despite the weak data and fears of a hard landing, not everyone is a bear on China. Business Insider notes that one research analyst expects signs of stabilization, and The Wall Street Journal reports that U.S. and other global fund managers are shrugging off the red flags and upping their bets on China:

Fund managers and financial advisers who increased their exposure even higher concede that China’s period of double-digit growth may be over. But, they add, the country’s long-term growth prospects—estimated at more than 8% by the World Bank—still trump many other markets and should continue to boost profits and eventually share prices.

Many also are encouraged by recent steps taken by Beijing to spur growth by loosening bank-reserve requirements and speeding up the approval process for infrastructure projects.

“Every year it seems there’s a growth scare from China, and every time it has been a buying opportunity,” says Mike Avery, co-manager of the $26.9 billion Ivy Asset Strategy fund, which recently raised its China stake to 20% from 18% at the end of last year.

Indeed, with Chinese stocks down about 12% over the past year, pros say many are trading at bargain prices. The MSCI China index, which tracks large- and mid-cap Chinese companies, trades at eight times next year’s earnings, about a third below its 10-year average. “China is safely cheap right now and gives you tremendous room for error,” says Jeff Everett, manager of the $360 million Wells Fargo Advantage International Equity fund. He has doubled the fund’s exposure to China and Hong Kong to about 10% since taking over the fund this year.

Fuel Prices Cut

While the PBOC’s rate cut attracted an understandably large amount of attention, it wasn’t the only move made by the government to fight the slowdown. China cut fuel prices by nearly 6%, the second reduction in a month and the largest since late 2008, in a move described by the National Development and Reform Commission as made in response to the global slump in crude oil prices. One former policymaker, however, told The China Daily that reform is still needed to allow China’s fuel prices to move with the rest of the world:

Under the current mechanism, started in 2008, the government may adjust fuel prices if the average movement of the three reference markets’ oil prices change 4 percent.

The current pricing program remains complex and not nimble enough to reflect global crude oil prices, said Zhou Dadi, former director of the NDRC’s energy research institute, adding that further reform to reflect supply and demand is a must.

The government may take the opportunity of global price drops to narrow the gap between international and domestic crude charges, and then introduce reforms to avoid volatility and market speculation, JYD’s Han said.

The revamp of the current pricing program is now just a matter of time, said Han Wenke, director of the NDRC’s energy research institute, and a guest China Daily economist.

Who stands to lose from the fuel price cut? China’s biggest oil refiners, according to Bloomberg,

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