China’s surprise rate cut shows how freaked out the government is by the slowdown

China’s rate cuts won’t stop the bleeding.
China’s rate cuts won’t stop the bleeding.
Image: Reuters/Reinhard Krause
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Earlier today, the People’s Bank of China slashed the benchmark lending rate by 40 basis points, to 5.6%, and pushed down the 12-month deposit rate 25 basis points, to 2.75%.

Few analysts expected this. The PBoC—which, unlike many central banks, is very much controlled by the central government—generally cuts rates only as a last resort to boost growth.

The government has been rigorously using less broad-based ways of lowering borrowing costs (e.g. cutting reserve requirement ratios at small banks, and re-lending to certain sectors).

The fact that the government finally cut rates suggests that these more “targeted” measures haven’t succeeded in easing funding costs for Chinese firms. The push that came to shove might have been the grim October data, which showed industrial output, investment, exports, and retail sales all slowing fast. Those data suggest it will be much harder to get anywhere close to the government’s 2014 target of 7.5% GDP growth, given that the economy grew only 7.3% in the third quarter, its slowest pace in more than five years.

But wait. Isn’t the Chinese economy supposed to be losing steam? Yes. The Chinese government has acknowledged many times that in order to introduce the market-based reforms needed to sustain long-term growth and stop piling on more corporate debt, it has to start ceding its control over China’s financial sector. Things like, for instance, setting the bank deposit rate artificially low, which generally punishes savers to benefit state-owned enterprises (SOEs).

But clearly, the economy’s not supposed to be decelerating as fast as it is.

Tellingly, it’s been more than two years since the central bank last cut rates, when the economic picture darkened abruptly in mid-2012, the critical year that the Hu Jintao administration was to hand over power to Xi Jinping. The all-out push to boost growth that followed made 2013 boom, but also freighted corporate balance sheets with dangerous levels of debt. But this could only last so long; things started looking ugly again in 2014.

Up until now, attempts to buoy the economy have mainly focused on helping out small non-state companies, says Mark Williams, chief economist at Capital Economics, in a note. Often ineligible for state-run bank loans, small firms have mostly been paying steep rates for shadow financing.

Since the benchmark rate cut affects official loans given out by mostly state-run banks, today’s cut will mainly benefit SOEs, hinting that the authorities “apparently feel larger firms are now in need of support too,” writes Williams. In addition, lowering the amount banks charge for capital makes them less likely to lend. Though that should in theory be offset by the lowering of the deposit rate, savers have been shunting their money into higher-yielding wealth management products, making deposits increasingly scarce.

On top of all that, the amount of investment it takes to produce a single unit of GDP growth has ballooned in recent years. That means it might take a lot more easy money than a rate cut will provide to keep the economy growing above the 7.0% mark.