The People’s Bank of China cut interests rates 2 days ago, (the fifth time since November), with the one-year deposit rate being reduced to 1.75% and the lending rate to 4.6% down 0.5%.
This reduction sent a tidal wave across the global markets with billions being slashed from the FTSE, DOW, NASDAQ, DAX AND CAC last night. Today there is a welcome recovery across the global markets whilst the Chinese stock market continues to take a pummeling.
The People’s Bank said that the interest rate cut was to reduce “the social cost of financing to promote and support the sustainable and healthy developments of the real economy”, but is this true and if so what is going on? We question four likely scenarios:
1 Managing the Country’s Debt?
Beijing’s banking heads are more concerned with managing debt than managing GDP growth. With total debt estimated at more than 240 percent of GDP, China paid far more in debt service charges last year than the total value of its economic growth. Thus bringing the debt load down is an essential part of safeguarding future growth.
2 Strategic Cuts?
Contrary to the above, the main argument against cutting rates so hastily is that such a policy has continued to ignite a domestic borrowing spree, while making US dollar stronger against the remnimbi. The People’s bank hasn’t been able to explain its position clearly in relation to this.
3 Drop in Industrial Profits?
Beijing needs to protect itself from the meltdown of industrial enterprises by cutting their interest burdens, in order to forestall a collapse in bank asset quality. Beijing is also clear that unless it tempers this downward momentum, the build up of defaulting loans in the banking system could explode as companies fail to service their bank debt. If that was to happen, fixed asset investments will fall which is the main driver of economic growth, which would be disastrous.
4 Rate cuts inhibited by surging capital outflows?
One key affecting rate cuts is a well-established pattern of capital outflows. As rates fall, investment funds leave the country’s coffers as they seek to improve their returns elsewhere, further devaluing the renminbi against the US dollar.
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