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The right call
Nov 21st 2014, 17:35 by S.R. | SHANGHAI
CHINA has cut interest rates for the first time in more than two years, a
powerful signal that the government wants to step up support for the slowing
economy. As fate would have it, a rate cut was the very thing we had called for
in our leader on Chinese monetary policy this week. But we cannot claim to be
clairvoyant. We had not expected the central bank to move so quickly. Nor, for
that matter, had most analysts or investors hence the big gains for stocks,
commodities and currencies sensitive to Chinese demand in the hours following
the announcement.
It is tempting to look at the rate cut through the simple lens of GDP: lower
rates mean China is switching policy to a pro-growth footing, or so the
conclusion would go. While there is undoubtedly some truth to that, two aspects
of the decision show it is more complicated, and indeed more interesting.
First, the People s Bank of China was at pains to stress that it was not, in
fact, about growth. The economy is growing within a reasonable range , it
said. Instead, it emphasised the need to reduce corporate financing costs to
help struggling companies. A knee-jerk criticism of the rate cute is that debt
in China is already too high and this will only encourage yet more borrowing.
But over the past year, rates have been too lofty for companies to be able to
deleverage. Because producer prices are in deflationary territory, the real
financing cost for many has been above 8%. With lower rates and a little more
inflation, companies will be able refinance more cheaply and, in time, lessen
their debt burdens.
This is certainly not the first attempt by the Chinese government to reduce
financing costs. Since September it has provided nearly 800 billion yuan ($131
billion) in medium-term loans to banks on the condition that they lower
borrowing rates for small businesses. Just this week the State Council, or
cabinet, promised to loosen a rule that limits banks loans as a proportion of
their deposit base, freeing up more cash for them to lend. The central bank has
also been quick to make short-term cash injections whenever the money market
has been gummed up. But as we wrote in this week s article, these efforts have
come up short. They have been far too narrowly focused and the PBOC s lack of
transparency has caused confusion about its real aims. Friday s announcement is
a welcome change in tack. It would now be surprising if China did not follow up
with more rate cuts and more cash injections.
Second, this is an important step on the path towards interest rate
liberalisation in China. Previously, banks were allowed to set deposit rates
10% above the benchmark level; that has now been raised to 20%. Competition
among banks to attract savers should ensure that banks offer the
highest-possible rates. One-year deposit rates were effectively 3.3% before the
rate cut (10% above the 3% benchmark). They are likely to remain 3.3% (20%
above the new 2.75% benchmark). At the same time, the benchmark one-year
lending rate has been cut to 5.6%. Theoretically, lending rates have already
been liberalised, with no floor on them; in reality, bankers say they still
price loans off the benchmark.
By narrowing the margin between deposit and lending rates, the PBOC is forcing
banks to pay savers something that is closer to the actual market price for
cash. The central bank also simplified the benchmark structure it will, for
example, no longer post a five-year rate. This gives banks more flexibility to
chart their own course in setting rates.
Zhou Xiaochuan, the long-serving PBOC governor, previously vowed to usher in a
full liberalisation of interest rates within two years. That is still an
ambitious goal, but China is now a little closer to it. An oft-heard view in
recent months was that the PBOC could not ease policy because doing so would
undermine its campaign to unleash more market forces in the financial system.
This always rang hollow. The rate cut shows that reform and easing can go
together.