China cuts rates again by modest margin as the economy struggles to recover

On Monday, China’s central bank reduced the primary benchmark interest rate utilized by the country’s commercial banks when issuing one-year bank loans. The move is part of a series of measures taken by the government to counteract declining real estate prices, sluggish consumer spending, and overall debt concerns. The People’s Bank of China (PBOC) lowered the one-year loan prime rate from 3.55% to 3.45%.

However, the rate reduction, which marks the second instance of the government lowering lending rates for commercial banks in two months, was smaller than initially anticipated. According to economists, this modest adjustment indicates that the conventional tools the government employs to address economic slowdowns might be losing some of their effectiveness.

In a note, Capital Economics, a research firm based in London, remarked that the move would only offer limited support to credit growth and broader economic activity.

China cuts loan rates

Stocks in Hong Kong, where many of China’s largest companies are listed, experienced a decline of more than 1 percent today, while shares in mainland China saw a decrease of around 0.50 percent.

The slight reduction in interest rates translates to a marginal decrease in the cost of borrowing money for both companies and households. That could lead to lower payments on existing loans. It’s important to note that the interest rates on most loans are typically adjusted annually, often at the beginning of each year. Therefore, the full impact of the central bank’s action on Monday might be apparent.

China’s central bank, the People’s Bank of China, lowered the one-year interest rate for commercial bank loans by 0.10 percentage points to 3.45 percent, less than anticipated. Notably, the central bank did not adjust its benchmark interest rate for commercial banks’ five-year loans, leaving it unchanged at 4.2 percent.

In a survey conducted last week involving 35 economists, all of them anticipated that the central bank would lower interest rates for one-year and five-year loans. The five-year loans are primarily utilized for determining interest rates on mortgages.

The previous week, the central bank implemented a 0.15 percentage point reduction in borrowing costs for commercial banks. By opting for a more conservative reduction in lending rates, policymakers effectively increased the profitability margins for banks.

China’s commercial banks have been heavily engaged in lending over recent years to real estate developers and individuals purchasing homes—groups that China’s housing market decline has particularly impacted. More than 50 real estate developers have defaulted or ceased foreign bond payments. 

The intricate financial framework of China’s state-controlled system has made it challenging for external observers to ascertain the extent of losses stemming from the banks’ involvement in real estate. Expanding profit margins on loans could aid these banks in amassing greater reserves to counterbalance these losses.

Catherine Yeung, the Investment Director at Fidelity International, pointed out that further interest rate reductions could be announced alongside government spending initiatives and specifically tailored measures aimed at supporting the property market. She noted that while Beijing is actively working to rebuild confidence, policymakers are also considering the potential lasting effects of these policies.

Growing headaches

China’s economy has encountered significant challenges in the aftermath of the global pandemic, which led to widespread shutdowns worldwide. Recent events have spotlighted the critical issues within its property market, as demonstrated by the bankruptcy protection filing of the troubled real estate giant Evergrande in the United States. Meanwhile, Evergrande is still negotiating with creditors over a multi-billion dollar deal despite its heavy debt burden.

Earlier in the month, another major property developer in China, Country Garden, cautioned that it might incur a loss of up to $7.6 billion for the year’s first half. Simultaneously, official data revealed that China entered a state of deflation for the first time in over two years. That was evidenced by a 0.3% decline in the official consumer price index, a gauge of inflation, in the previous month compared to the same period a year earlier.

Additionally, China’s imports and exports experienced a sharp decline in July due to weaker global demand, which threatened the country’s prospects for economic recovery. Beijing’s decision to stop releasing youth unemployment statistics, considered by some as a crucial indicator of the nation’s slowdown, raised concerns. In June, the jobless rate for individuals aged 16 to 24 in urban areas of China reached a record high, exceeding 20%.

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