China’s stimulating dish

China’s central bank has served up “a dish of stimulus” with “a side order of banking reform”, says Aaron Back in The Wall Street Journal. The People’s Bank of China cut interest rates for the first time in two years last week. The unexpected move lifted stock and commodity markets. The benchmark one-year lending rate has been cut by 0.4 percentage points to 5.6%; the 12-month deposit rate fell a quarter point to 2.75%.

The Chinese economy has slowed sharply in the past few years. The authorities are trying to engineer a soft landing after a credit and property binge. As a result, China could miss its annual growth target – 7.5% this year – for the first time since the Asian crisis in the late 1990s. The authorities also want to encourage households to consume more, rather than encouraging economic growth through building infrastructure.

Some central-bank members resisted the cut, says Alex Frangos, also in The Wall Street Journal. They thought it would undermine the “broader reform agenda” of weaning China off credit-fuelled growth. But “short-term growth concerns have won out”. In any case, this rate cut is unlikely to re-inflate the credit bubble, reckons The Economist’s Free Exchange blog.

The important point is that interest rates have become too high for companies trying to pay down their debts. Producer price inflation has turned negative, adding to the burden of corporate debt (when prices – and therefore income – falls, debt gets harder to service because interest payments are fixed). For many firms, real financing costs have crept above 8%. Lower rates will allow them to rearrange their loans at cheaper rates, making it easier to repay their debts.

But there is unlikely to be a surge in overall lending, due to strict quotas and loan-to-deposit ratios governing the amount banks can lend out. Unless these are relaxed, there will be little impact on growth, says Capital Economics – which the central bank seems quite happy about in any case. So the main impact of the cut “will be to improve the financial position of large firms”. And it’s also a small step towards interest-rate liberalisation, notes The Economist. The cut in the deposit rate was matched by a new rule allowing banks to set deposit rates 20% above the benchmark, compared to 10% before. Competition should ensure higher deposit rates overall, promoting saving, and, in the long run, consumption.