China took the market by surprise by announcing a 27 basis point cut in the nation's benchmark lending rate yesterday. The cut, coming amid turmoil in the global financial sector, lowers the cost of one-year bank loans to 7.20 percent and is effective from today. The People's Bank of China also lowered the reserve requirement for all lenders except the country's five biggest banks and the Postal Savings Bank by 1 percentage point. It is the first time that the PBOC has lowered the proportion of deposits that lenders must hold in reserve since November 1999. The cut in reserve requirements is effective from September 25, the central bank said.
Industrial output grew by 12.8% year on year in August, versus 14.7% in July, and 17.5% last August. There was weakness in almost every sector, with iron and automobile production actually contracting versus one year ago. Clearly the industrial sector is slowing, and this puts all the more pressure on rising consumer demand to keep the economy strong.
Retail sales grew by 23.2% year on year in August, slightly less than July’s 23.3% but substantially better than last August’s 17.1%. This growth, however, may have more to do with Olympics spending than with long-term trends, and we will probably need to see September and October numbers to get a real sense of how consumers are responding.
Loan and M2 growth were also slightly weaker than expected. The continued rapid growth of foreign currency reserves at the PBoC is probably being countered by the sharp fall in real estate and stock prices to represent money growth below what we would have expected. The fact that loans in the banking system grew by less than they could have under the loan caps, suggests that either companies are reluctant to borrow and invest because of concerns about the slowing economy, or that banks are reluctant to lend because of credit fears.
The slowing Chinese economy is understandable, it was engineered. The central bank wanted to curb hot money in stocks and property. They have been quite successful in both. A bit too successful in fact that they are now a bit worried. A couple of weeks ago, they came out with renewed infrastructure spending. If you were to be in China and ask around, many businesses are frozen because they cannot get new funding. So much so that many are relying on informal sources of funds. The lowering of the reserve requirement is a big sign that Beijing is keen to ease the water tap. Same for the lowering the bank lending rate. We can expect similar easing moves in rapid succession.
The initial moves may not move the dinosaur, it will take a couple more moves to ease both rates before investors gain sufficient confidence. Still, these are important steps in deciphering the thinking behind the central bank of China.
p/s photos: Carissa Putri