By Michael Lelyveld
Major challenges continue to confront China’s economy following the first interest rate cuts in over two years.
While regulators have resisted calls for a return to full-blown stimulus policies to revive economic growth, they have responded with modest monetary easing that may do little to ease pressures or avert further declines.
On Nov. 21, China’s central bank announced a cut in the benchmark one-year lending rate by 0.40 percent to 5.6 percent, while lowering the one-year deposit rate a quarter-point to 2.75 percent.
The surprise move won favorable reviews from some analysts and foreign media after months of concern about weakening growth in industrial and property sectors.
“It will obviously reduce financing pressures for bank borrowers. Typically, those are larger companies, state-owned companies, so they’re the main beneficiaries of this,” Mark Williams, chief Asia economist at Capital Economics in London, told Reuters.
“The action will lift the country’s flagging housing market and large state-owned companies, as well as bolster other nations that have come to rely on those core parts of China’s economy,” The New York Times said.
Mixed reactions
But other reactions to the response from the People’s Bank of China (PBOC) were mixed, as regulators appeared squeezed between promises to avoid previous stimulus policies and pressure to do more.
“An aggressive easing campaign and a sharp turnaround in the fortunes of China-linked investments will remain illusive,” said The Wall Street Journal in its “Heard on the Street” column.
“China is poised to deliver deeper interest rate cuts after [the] unexpected decision to reduce borrowing costs for the first time since 2012,” Bloomberg News said.
One concern is that the uneven rate reductions will slash bank profits, as the PBOC also raised its cap on allowed returns for deposits from 110 to 120 percent of the benchmark level, leaving them effectively unchanged.
Jiang Jianqing, chairman of Industrial & Commercial Bank of China, complained that the formulas would “inevitably squeeze the profit margins of banks, and the narrower margin is a long-term trend,” Bloomberg reported.
Officials have said little about the banks’ concerns.’
‘Big step forward’
On Nov. 27, PBOC vice governor Hu Xiaolian called the rate change “a big step forward” for financial reforms and “also a step toward full liberalization of deposit rates,” the official Xinhua news agency said.
The State Council, or cabinet, took a further step that may lead to deposit rate liberalization by publishing draft rules on deposit insurance on Nov. 30.
Under the plan, China’s banks would pay insurance premiums into a fund that would cover accounts against potential losses up to 500,000 yuan (U.S. $81,500) per depositor, Xinhua reported.
The law on deposit insurance could go into effect early next year, Reuters said.
Last week, China’s stock markets responded positively to the expectation of lower loan rates to come as the Shanghai Composite Index rose over 8 percent, regaining some ground after the slump of the past four years.
But perhaps a greater question was whether the rate cuts would have any significant or lasting effects on the economy.
Targeted steps
The PBOC move follows a faint response to several “targeted” steps that the government has tried to distinguish from the massive 4-trillion yuan (U.S. $651-billion) stimulus plan in 2009 that left China mired in pollution and debt.
This year, China has tried pumping funds into rail projects, injecting liquidity into select banks and offering 30-percent discounts on mortgages for buyers of second and third homes.
But the mortgage gambit may have been particularly ineffective as a spark for the sluggish property sector.
On Nov. 1, Xinhua quoted a manager of Agricultural Bank of China as saying that deep mortgage discounts were “almost impossible” because state-owned banks were burdened with costs from their offerings of high-interest wealth management products (WMPs) to investors.
“A great amount of bank deposits are taken from wealth management programs with a high return promise. Big mortgage loan discounts mean losses to banks as the cost of taking a deposit is high,” the unidentified manager said.
The most that banks were expected to offer after the new PBOC mortgage rules announced on Sept. 30 was a discount of perhaps 10 percent, Beijing News and the official English-language China Daily reported.
Interest rate concerns
Last week, Xinhua voiced an opposite concern about the broader interest rate cut, citing signs that it may have produced a sudden 54-percent spike in Beijing’s apartment sales during the week following the announcement, as prices jumped 10 percent from the previous week.
But the lenders’ complaints suggest that PBOC policies may have hit a wall in trying to steer the economy away from shadow banking.
The alternate-channel financing has been estimated at nearly U.S. $3 trillion (18 trillion yuan) last year with outstanding WMPs of U.S. $2 trillion (12 trillion yuan) as of mid-2014.
It is unclear whether the rate cuts will have longer-term benefits for real estate developers, since the sector has relied heavily on shadow bank loans.
China’s banks have little incentive to dig deeper into the real estate market in any case.
“Developers have huge inventories of unsold homes, and increasingly risk-averse banks are wary about financing new mortgages which would only increase their exposure to the weakening sector,” Reuters said after the discount announcement.
Discouraging data
Housing data from the National Bureau of Statistics (NBS) has been discouraging so far.
New home prices in October fell in 69 of China’s 70 major cities from a month earlier, the NBS reported, while 67 cities showed year-on-year declines.
Property sales in terms of floor space fell 7.8 percent in the first 10 months, contributing to the slowdown in economic expansion.
“The continuing downturn in the property market dragged down growth in the broader economy, which slowed to 7.3 percent in the third quarter,” Xinhua reported, reflecting a five-year low in the growth rate.
Early returns for November continued the trend as home prices slipped in 82 monitored cities and rose in just four, the independent China Index Academy research group said.
Afloat on credit
Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, said that China’s economy is unlikely to respond like Western markets to monetary measures.
“Interest rates don’t matter in China,” said Scissors, arguing that state-owned enterprises (SOEs) have been kept afloat on credit for years and that none have ever been forced into bankruptcy over debts.
Last year, the total debt of SOEs climbed 16.7 percent to 67.1 trillion yuan (U.S. $10.9 trillion), the Ministry of Finance reported in July.
“For people outside the state banking system, there’s also no evidence at all that their cost of capital is related to the benchmark interest rate,” Scissors said.
Response unlikely
Further monetary easing is seen as unlikely to elicit a response similar to the 2009 stimulus because China is already overloaded with liquidity and debt.
Scissors believes the PBOC rate cuts may still have significance because they suggest that the government recognizes that previous attempts to deal with the slowdown have failed and it wants to reassure investors.
But beyond that, the moves may prove meaningless for the economy in the absence of sweeping reforms.
“Their credit transmission system is broken,” said Scissors.
“There’s an enormous amount of liquidity and yet they need to loosen more, and the reason they need to loosen more is that people don’t want to lend and people don’t want to borrow,” he said.
“They’ve tried to push the monetary button too many times and now they’ve pushed it and nothing happens,” he said.
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