China’s central bank took a significant step on Tuesday by reducing key interest rates for state-controlled bank loans. This move reflects growing concerns within the Chinese government and corporate sector about the country’s stagnant economy.
Although the interest rate cut was small – a mere tenth of a percentage point for one-year and five-year benchmark rates – its impact could potentially influence the overall pace of economic growth since the majority of corporate lending and mortgages in China are tied to these rates.
Interestingly, China’s decision puts it at odds with Western policies. While the Federal Reserve recently paused its year-long battle against inflation by raising rates, the European Central Bank has also been increasing interest rates in response to inflation. In contrast, China faces an entirely different problem: weak spending and private sector investment. This has prompted businesses to engage in price-cutting wars to retain customers, leading to a decline in consumer and producer prices for the past four months.
Despite the central bank’s efforts, investors seemed unimpressed. Share prices slipped across Asia, particularly in Hong Kong, indicating that the rate cut was smaller than anticipated and highlighting the struggles of the Chinese economy.
Additionally, China’s currency, the renminbi, weakened against the dollar. In recent months, the lower interest rates in China compared to the United States have incentivized companies and households to move their money abroad, bypassing China’s restrictions on large overseas fund transfers.
Explaining the slow impact of rate cuts, Han Shen Lin, a former deputy general manager for China at Wells Fargo Bank and current finance professor at New York University in Shanghai, compared it to gradual medicine for the Chinese economy. Corporations negotiate their borrowing limits annually, taking out loans for durations ranging from weeks to months. Only when new loans are issued or existing loans are rolled over do the lower interest rates come into effect.
The central bank’s reduction on Tuesday will gradually permeate the system, according to Mr. Lin.
However, households may have a longer wait to reap the benefits. In China, mortgage interest rates are typically adjustable, but adjustments often occur in January, as clarified by the central bank in its accompanying statement. Therefore, while homebuyers in the coming months may benefit from the rate cuts, existing homeowners will need to exercise patience.
This Tuesday’s move marks the first reduction in loan rates by China since August of last year when the economy was still struggling following a two-month COVID lockdown in Shanghai. The government’s desire to stabilize output during a time of falling exports, stagnant construction, and weak consumer confidence becomes evident through these latest cuts. It is worth noting that the sudden abandonment of COVID controls by the Chinese government at the end of last year had initially sparked hope for a swift recovery.
However, the modest scale of the interest rate reductions suggests economic policymakers in China are concerned but not panicking. In contrast, during the global financial crisis in 2008, China’s central bank slashed benchmark loan and deposit rates by 1.08 percentage points in a single day. Similarly, during the late 1990s Asian financial crisis, China reduced loan rates by 1.44 percentage points in one day.
With this recent cut, the one-year benchmark rate has decreased from 3.65 percent to 3.55 percent, while the five-year rate, which serves as the basis for mortgage rates, dropped from 4.3 percent to 4.2 percent. Typically, companies pay the benchmark rate plus an additional percentage, with smaller businesses generally paying more than larger corporations and state-owned enterprises.
In summary, China’s central bank’s decision to cut interest rates signals their concern about the stagnation of the country’s economy. While the rate cut may take time to fully impact the system, it conveys the government’s intent to stabilize output amid various economic challenges.
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