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Interest rate cut to shore up investment

By Ye Tan (China Daily)
Updated: 2008-12-03 09:32

The biggest interest rate cuts made by the People's Bank of China in 11 years demonstrate the central government's strong determination to curb a further slide of the economy in the context of the world's financial crisis.

The central bank made a decision last Wednesday to cut 108 basis points respectively on the benchmark one-year lending and deposit interest rate from the following day. It also said as of December 5, it would lower the reserve requirement ratio by 1 percentage point at large banks and 2 percentage points at small and medium-sized financial bodies. Large banks involved include the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, Construction Bank of China, Bank of Communications, and the Postal Savings Bank of China.

An unexpected move, the 1.08 percentage point cut is the largest since the Asian financial crisis in 1997 and also the fourth in three months. The central bank lowered the interest rate for one-year lending and saving by 27 basis points in each of the previous three times.

As the final effects of the international financial tsunami are yet to show up, the latest move also indicates mounting government concerns that the country risks spiraling unemployment and social problems under a slowed economy.

There have been conflicting viewpoints on whether interest rate cuts alone could rescue the steering global economy from collapse. But that did not stop the world's main central banks from cutting their interest rates several times simultaneously.

It has been a common consensus among economists and financial experts since the end of World War II that a lowered interest rate could help slow economic downturn and prevent a tightened economic and financial policy causing excessive damage to the real economy.

With the Consumer Price Index, a measurement of prices for a range of consumer products, in the US and Japan staying at the current levels, the world's two largest economies in essence hold a negative interest rate policy. However, the Organization for Economic Cooperation and Development (OECD) still urged the two countries to continue to lower their interest rates. According to the multilateral economic group, the Federal Reserve should lower its key interest rate to 0.5 percent from 1.0 percent and the European Central Bank should reduce its key interest rate to 2 percent from 3.25 percent early next year. The organization also called on Japan to maintain its 0.3 percent key interest rate till 2010.

After the latest large-margin cut, China's interest rate would also be at the negative level. In October, the country's CPI growth rate was still 4.0 percent from the same period of last year. But the interest rate for the benchmark one-year deposit was only 2.52 percent under the new interest rate policy. If the Federal Reserve were to lower the US interest rate by a 0.5 percentage point, as demanded by the OECD, then that would leave room for China's Central Bank to continue to chop another 54 basis points or more for the country's interest rate and lower the reserve requirement ratio for domestic financial bodies.

The latest interest rate slash by the central bank and its bigger stride in reducing the reserve requirement ratio are symbolic of government efforts to encourage the country's enormous reservoir of deposit, worth tens of trillions of yuan, to flow to the fields of investment and consumption as the main means to lubricate the already slowed economy.

A decline in the lending rate would also reduce domestic enterprises' financing costs and boost their investment sentiment under the current discouraging economic and market conditions. It has long been the central bank's main target to maintain a steady economic growth and keep unemployment and inflation below a certain level. In a time of economic contraction, raising the country's employment rate and increase investment serves as the key to boosting domestic demand and bolstering the whole economy.

However, we should not remain too optimistic about the effects of the latest rate cut on the economy. What kinds of effects the move will have on the country's economy still remains unknown, given that the cuts do not inevitably mean commercial banks would change its previous reluctance to extend credit to struggling enterprises. Any rush would put them under financial risks. Also, a steep cut on interest rates may plunge the country into fluidity excess if we cannot improve the efficiency in the use of the released funds.

The interest rate cuts, alongside the reduced reserve requirement ratio, did help boost the country's fluctuating stock market after their announcement. Upon the issuance of the new interest rate policy, the prices of the world's bulk commodities rocketed.

However, a steady and advancing stock market in the long run should depend on the performance of listed companies and government attitudes toward non-tradable shares. The pouring of these shares into the stock market has been blamed as the main reason for the decline of Shanghai Composite Index shares from last year's peak of 6,000 points to the present 2,000-point level.

Also, the latest rate cut would help ease to some degree the funding insufficiency the country's real estate industry has suffered.

The author is a Shanghai-based commentator on finance and economics.