China cuts interest rates

The People’s Bank of China has cut loan and deposit rates by 27 basis points (bp) each, the fifth cut since September as the central bank tries to stimulate the economy.

However, Mark Williams, Asia economist at Capital Economics, says he was expecting a larger cut and fears the 27 basis point reduction may not have much impact on the economic slowdown.

The benchmark one-year lending rate falls to 5.31% from 5.58% and deposit rates descends to 2.25% from 2.52%, according to Capital Economics.
WiIliams says: “We initially penciled in a 54 bp cut before the end of the year but after Zhou Xiaochuan’s announcement last week we thought it might be even more.”

Zhou, a central bank governor, said in Hong Kong that rate cuts would depend on the rise of the Consumer Price Index (CPI).

On December 11, the National Bureau of Statistics reported China’s CPI rose at an annual rate of 2.4% in November and had slowed for seven straight months.

Williams revised his forecast to a cut of 108 bp.

He says: “We are not entirely clear on why there was only a cut of 27 bp. My view is that interest rate moves do not have a huge impact on the economy and borrowing or investment decisions but they are useful in signaling to the private sector the government’s determination to support the economy.”

He adds that there are only so many rate cuts that can take place so the government may be leaking these out as slowly as possible. The danger is, he says, this could be ineffective and leave market participants either nonplussed or disappointed.

He expects another cut of 27 bp in the next few weeks and for rates to be lowered by a further 54 bp by the end of the second quarter of 2009.

However, he adds this will not help the halt the slowdown alone.

“The critical thing now is fiscal policy. Monetary policy may help a bit but fiscal policy really is absolutely critical. The government has already pledged some bold moves to support the economy including a huge stimulus package but we are still waiting for the details. There are concerns that when it does arrive it may actually be too small or that it arrives so slowly, it might not be much help to the economy.”