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China cuts interest rates to stop market rout (but won’t admit it)

After sitting on its hands for two days in which the local stock market fell over 15%, China’s central bank Tuesday cut its official lending rates and its reserve requirements on local banks in what appeared to be an effort to stop the rot.

The People’s Bank of China said it will cut its one-year lending rate by 0.25 percentage point to 4.6% and its benchmark one-year savings rate by 0.25 point to 1.75%. Just as importantly, it will cut the reserve requirement ratio on most large banks by 0.5 percentage point, freeing up around $100 billion in liquidity that may now be lent to the economy instead of being hoarded at the central bank.

The move provided an immediate sugar rush to global markets that had, in any case, rebounded healthily after Monday’s turmoil, when fears about the strength of the Chinese economy sent prices for stocks and commodities tumbling.

However, the action left some observers bemused, appearing too little, too late, to restore confidence in policy-makers’ ability to keep the market orderly as the bubble deflates. The authorities had intervened aggressively through all of July and early August to keep stock losses within bounds, but had appeared to give up direct intervention since then, allowing the Shanghai composite index to fall another 25%. After a 7.3% drop on Tuesday, the SHCOMP is down 43% from its peak in June.

In an exhaustive policy statement on its website, the PBoC surprisingly made no reference to the carnage on the mainland stock market in the last two days. The Shanghai and Shenzhen markets have lost over 15% in that time, not least on disappointment that the PBoC hadn’t delivered any more stimulus since allowing the yuan to depreciate against the dollar for the first time in 21 years earlier this month.

The last week has shown what happens when Beijing stops propping up the market in Shanghai.

 

“This round of targeted RRR cuts aims at strengthening the capacity of financial institutions to support the developments of agricultural sector, rural areas and farmers and micro and small enterprises, reinforcing the positive incentive, supporting the key areas and weak sectors in the national economy and providing financial support to popular entrepreneurship and innovation,” the PBoC said.

 

China's companies have been cutting prices for the last three years.
Stock market deflation mirrors a longer deflation process in producer prices. Source: ieconomics.com
ieconomics.com

 

There’s no denying that high real interest rates (see below) have been punishing China’s corporate sect0r, compounding the problems caused by three years of deflation in factory gate prices.

Reading the tea-leaves, Nick Kounis, an analyst with ABN Amro in London, said there is more easing “on the cards” after the PBoC said in its statement that it will use its policy tools “flexibly” and dropped its usual reference to “prudent” policy making.

But Tuesday’s action is unlikely to make the difference between life and death for many companies on its own, analysts said. And whether it will stop the exodus from the Shanghai and Shenzhen markets is another matter entirely.

 

Rates of discomfort Source: ThomsonReuters
ThomsonReuters