06/29/2015
China / Rates
The People’s Bank of China cut interest rates again over the weekend. But this is unlikely to revive the country’s sluggish economy.
The People’s Bank of China (PBOC) cut interest rates again over the weekend. The benchmark one-year lending rate and one-year deposit rate were both lowered by 25 basis points to 4.85% and 2.0%, respectively. The reduction of the reserve requirement ratio (RRR) by 50 basis points, however, is only restricted to city commercial banks with a strong lending bias to agricultural development-related activities. This is the fourth interest rate cut in the past seven months. Although the interbank money market rate has apparently fallen during the period, real economic activities have remained sluggish.
The lack of aggregate demand is primarily due to the sharp fall in fixed asset investment due to political factors, much more so than the level of real interest rates. The monetary transmission mechanism does not work as intended when the economy is going through a structural transition, characterised by credit deleveraging and the indigestion of industrial overcapacity. That is why the lower cost of capital would unlikely create strong loan demand at this juncture. Economic growth in the second half will likely remain benign and, at best, slightly better than in the first half. Both the interest rate and RRR will fall further for the rest of the year.
Understandably, it is hard not to speculate that the latest interest rate cut was somewhat related to the sharp fall of the A-share indices in China last week, as the timings of previous rate cuts have coincided with sharp falls in the equity market at least twice this year. That said, it also does not make logical sense that the authority would take the risk of engineering a bull market without adequate justification in economic fundamentals. Even then, such an inter-temporal positive wealth effect will not last.
