Bank of China

Rate cut reflects economic task ahead

PUBLISHED : Saturday, 07 July, 2012, 12:00am
UPDATED : Saturday, 07 July, 2012, 12:00am

China's surprise move to cut interest rates twice in a month underscores the task the mainland has ahead of it: spurring growth - and employment - to keep social unrest at bay.

Many economists, though, say this month's action won't be enough, and the central bank will be forced to cut rates at least two more times this year, as well as further relax the so-called reserve requirement ratio, the amount of reserves that banks are required to keep on hand.

Both measures effectively free up credit in the financial system so banks can grant more loans.

Data due to be issued next week is likely to show the economy grew slower than expected last month and in the second quarter of this year. In the first quarter, the economy expanded 8.1 per cent from a year earlier, but that was the weakest performance in three years.

The slowing is starting to take its toll. Just this week, the Sany Group, the mainland's biggest maker of construction machines by revenue, quietly began laying off hundreds of workers, sending a chill through Beijing, where leaders are already grappling with brewing general discontent and worrying that job losses will turn into street protests. This week, for instance, violence erupted in Shifang, Sichuan, not over jobs, but over environmental and health concerns about a proposed metal processing plant. After three days of protests, the city's party chief backed down and promised to scrap the plan.

As for investors, they 'appear to no longer care about China's growth for this year - whether 7.5 per cent, 8 per cent, or 8.5 per cent - it doesn't matter any more', said Joy Yang, chief economist for Greater China at Mirae Asset Securities in Hong Kong.

She says what really concerns them at this point is a realisation that 'it's no longer a cyclical issue, but a structural issue' of transforming the mainland's export-reliant economy to one that is driven by domestic consumer spending.

But there is no quick fix to effect such huge economic structural reforms. Meanwhile, economic and political analysts contend that the current leadership, which is set for a once-in-a-decade change in the autumn, is willing to apply only minor steps such as rate cuts in the hope of giving the economy a fillip, leaving the hard work for the next team.

Many economists, including from Goldman Sachs and Mizuho Securities, believe the People's Bank of China will cut the benchmark interest rate at least twice more this year. Mizuho's China chief economist, Shen Jiangguang, predicts economic growth for the second quarter may be up 7.2 per cent from a year ago.

The government's official target is for the economy to expand 7.5 per cent this year. But investors have come to expect official targets to be exceeded, and 8 per cent growth has become the psychologically important figure this year, economists say.

The PBOC may be even more aggressive in cutting the reserve requirement ratio two or three times more before the end of the year, says Hu Yifan, chief economist for Haitong Securities International in Hong Kong. The ratio has been lowered three times since November.

'We expect more supportive policies to promote consumption and infrastructure,' Hu said.

The rate cut that took effect yesterday helped send the benchmark Shanghai index up 1 per cent from Thursday's close. Hong Kong's market was flat, London's FTSE 100 was down 0.53 per cent 45 minutes before the close, while the Dow Jones Industrial Average was down 1.25 per cent in late morning trade.

Along with the PBOC, the European Central Bank on Thursday cut rates below 1 per cent for the first time, to 0.75 per cent, and the Bank of England said it would inject ?50 billion (HK$606 billion) into the financial system to kick-start the British economy. Still, investors seem doubtful about such global efforts.

'The overnight joint actions by global central banks once again have failed to impress. It is a cry for help, a sign of desperation, and a declaration of the market's dependence on central banks' liquidity lifeline,' said Hong Hao, chief China strategist at Bank of Communications International Research in Hong Kong.