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China Cuts Rates to Boost Economy


China announced its biggest interest rate cut in 11 years, extending efforts to prevent an economic slump after unveiling a stimulus package.

By Caijing chief economist Shen Minggao and staff reporter Zhang Huanyu

From Caijing Online

China's central bank announced its biggest interest rate cut in 11 years on November 26, as the latest effort to stimulate domestic spending and growth amid the global economic slowdown.

The People's Bank of China cut its key one-year yuan lending and deposit rates by 1.08 percentage points each, to 5.58 percent and 2.52 percent, starting from November 27. This is the third deposit rate cut since early October.

The bank said it will also cut the reserve requirement ratio from December 5 by one percent for large banks and by two percent for small and medium-sized banks.

Three weeks after the unveiling of a four trillion yuan stimulus package, the recent rate cut is China's largest since the Asian financial crisis a decade ago, highlighting the government's concern about the economic slowdown.

The cuts are aimed “at ensuring sufficient liquidity in the banking system and to promote steady loan growth so that monetary policy can play an active role in supporting economic growth,” the bank said in a statement.

The cut in the deposit rate is hoped to boost domestic spending and the reduction of the lending rate will cut financing costs for enterprises to encourage investment, but the effect will rely on the market's confidence in the economic outlook. Many analysts think that China may need further rate cuts to prevent the economy from declining.

Gao Shanwen, chief economist of Essence Securities, forecasts that the central bank may further lower interest rates by one to one and a half percentage points, because rate cuts are an effective method to boost the sluggish property market which is seen as a key driver for China's economy.

Ha Jiming, chief economist of China International Capital Co., said that threatened by economic slowdown and deflation, the central bank would reduce interest rates by as much as 2.16 percentage points over the next year, while cut the reserve requirement ratio by 3.5 to 5.5 percentage points. “But future rate cuts will not be as sharp as this time,” said Ha.

Guan Wensheng, head of the China research department at Barclays Capital Asia, predicted that the central bank will further reduce interest rates by 0.54 percentage points and 0.81 percentage points in December and the first quarter 2009 respectively.

The easing of monetary policy along with the recent stimulus package should encourage bank lending and alleviate capital pressure on enterprises. But, Ma Xutian, deputy manager of ICBC's financial markets department, said that “it won't help if enterprises are already in bad shape and unable to service existing debt.”

The rate cut has lowered the one-year yuan deposit rate to 2.52 percent, which may encourage Chinese consumers to spend rather than save. But lower deposit rates only encourage short-term increases in consumption. Aiming to boost long-term sustainable consumption, the government also issued policies to increase citizens' stable property income, such as expanding the corporate bonds market.

Despite easing monetary policy to revive market confidence and prevent economic slowdown, China also needs more effective financial policies, such as tax reduction, to stimulate rural consumption and accelerate the development of the service industry.

China's economy has slowed due to distressed growth in exports and property investment. The GDP growth dropped to 9 percent in the third quarter from 10.1 percent in the second, its slowest pace in over five years.