The People’s Bank of China (PBOC) announced to cut its benchmark interest rate by 25 bps, effective on 8 June 2012. This is the first rate cut since September 2008 and the first price-oriented monetary policy since July 2011. The cut brings the official 1-year lending rate to 6.31% and the 1-year deposit rate to 3.25%. Other deposit and lending rates, as well as the individual housing provident fund deposit and lending rates were cut accordingly. In addition, the PBOC decided:
- To adjust the ceiling of the floating range of interest rates on deposits for financial institutions to 1.1 times of the benchmark interest rate
- To adjust the floor of the floating range of interest rates on loans for financial institutions to 0.8 times of the benchmark interest rate
|Table 1: Adjustment of Benchmark Deposit and Lending Rates, Effective on 8 June 2012
|Source: PBOC, iFAST Compilations
The move caught the markets by surprise as economists widely expected the central bank to leave the deposit rate unchanged, and as the banks took an important step towards interest rate liberalisation by broadening the floating range of deposit and lending rate. In this article, we explain the reasons for the rate cut, and the implication of broadening the floating range of deposit and lending rate.
TWO REASONS FOR THE RATE CUT
The Chinese Economy Is Going Down
The main reason is that almost all of the economic indicators in April were surprisingly weak. For example, industrial production barely recorded a 9.3% year-on-year growth, the first single digit and the lowest growth since May 2009. What’s worse is that, from the production classification perspective, the slowdown seems to be broad-based. The total retail sales of social consumer goods increased 14.1% year-on-year, the lowest since October 2002. It was also worse than market expectations and the growth rate a month earlier. New loan issued by Chinese financial institutions fell below 700 billion yuan in April as a result of weak aggregate demand, while the monetary policy came in less loosening than expected.
As the three main growth drivers of the Chinese economy (consumption, investment and exports) show signs of slowing down, it is widely expected that the country’s quarterly GDP growth will take more time to bottom out. Thus, we believe the move is necessary, which shows the determination of the government to boost economic growth.
Abnormal Situation In The Credit Market
In addition, even the PBOC has lowered the required rate of reserve twice this year, the overnight Shanghai Interbank Offered Rate (SHIBOR) continued to drop while the weighted average interest rate for general loan inched up. This divergence reflects that banks prefer to hoard cash rather than to lend as their risk appetites have decreased in the face of climbing non-performing loans. The weak new loan figure in April also reflects the bank’s unwillingness to lend.
On the other hand, there are signs suggesting that Chinese corporates are unwilling to borrow. For instance, new short-term loans made to non-financial enterprises exceeded the new medium-to long-term loans in April 2012. In fact, the short-term loans are taking up a higher proportion of the total new loans since 2012, while the 6-month bills discount rate of the major regions like Yangtze River Delta has been decreasing since this year. These explain the fact that the corporates are not willing to borrow as they expect their earnings will be impacted under a bad economic climate. We believe a rate cut is highly appreciated and the loosening monetary policy can reduce the cost of capital and help to arouse the demand for funds.
THE IMPLICATION OF BROADENING THE FLOATING RANGE OF DEPOSIT AND LENDING RATE
One notable feature of this rate cut is that banks can offer a saving rate equivalent to 1.1 times of the benchmark interest rate (which in other words could be a rate hike) while they are allowed to set a lending rate as low as 0.8 times of the benchmark interest rate. Therefore, it can be regarded as an asymmetric rate cut. Comparing with a symmetric rate cut which should maintain bank’s profitability, an asymmetric rate cut is a significant step towards interest rate liberalisation, while banks’ net interest margin would be narrowed.
Furthermore, an asymmetric rate cut can maintain a positive real deposit rate. China’s inflation pressure has been easing as evidenced by the recent slowing CPI growth. Still, contrast to the market consensus on Chinese inflation for the year of 2012 (above 3%), the 1-year real deposit rate is close to zero. On the other hand, the producer price index (PPI) has dropped drastically since October last year and has seen a year-on-year decline since February 2012. As a result, Chinese enterprises are now facing higher real borrowing costs (lending rate). Hence, it is sensible for the central bank to take an asymmetric rate cut.
IMPLICATIONS FOR THE ECONOMY
After looking at the rationale behind this surprising rate cut and its notable features, in Views on China’s Surprise Rate Cut (Part 2) – Implications for the Economy, we will take a look at the implications of the policy move for the overall economy. In addition, we will also discuss the possibility of a further monetary and fiscal policy easing in China.
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