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Tom Holland

Market watchers welcomed last Thursday's interest-rate cut by the People's Bank of China as a timely signal that Beijing is prepared to do whatever it takes to support economic growth in the face of a deepening slowdown.
It was the right reaction, but for altogether the wrong reasons.
On the surface, an interest-rate cut looks like a solid response to a string of recent economic data all showing activity is softening fast.
And in another economy it might be that. In another economy, lowering the cost of credit might provide the counter-cyclical boost needed, encouraging businesses to invest and consumers to spend, so keeping things ticking along despite weaker external demand.
But in China things work differently.
In China, changes in borrowing rates make little or no difference to the amount of money banks lend out to businesses. That's because the country's state-controlled banks lend disproportionately to state-owned firms or local government-linked investment projects.
And the managers of both are typically more interested in growing their assets than in making a profit. They care little about interest rates, because they know if they run into difficulty servicing their debts, they can always pull political strings to get them rolled over on easy terms.
That's why the authorities have traditionally relied on quotas to regulate the pace of lending. Adjusting interest rates doesn't work.
As a result, last Thursday's quarter percentage point cut in benchmark lending rates will do nothing to boost lending, although it will make servicing existing loans easier for highly-leveraged state-owned companies like power generators.
Nor in China does cutting interest rates encourage consumers to go out and spend - quite the reverse. Consumer credit is still in its infancy.
But ordinary households are sitting on huge savings deposits worth some 36 trillion yuan (HK$44 trillion). And the returns on those savings are derisory. Roughly half are in the form of demand deposits, which now carry a benchmark interest rate of just 0.4 per cent. Assuming the time deposits which make up the remainder are in all one-year fixed deposits, that means after last week's cut the average return on household savings accounts is now just 1.8 per cent.
With inflation running at a 3 per cent rate in May, households are making a real loss of 1.2 per cent a year on their savings. Any more cuts in deposit rates will only further discourage consumer spending.
In short, interest rates in China are too low, not too high. Bank credit, for those with the political connections to access it, is too cheap, and so is frequently mis-allocated. And depositors earn a negative real return on their savings. 
Cutting interest rates only distorts things further.
But the authorities didn't simply cut interest rates last week. Although they did reduce benchmark rates for both loans and deposits, they also allowed banks a little freedom to deviate from official benchmarks.
From now on, banks will be able to make loans at a discount of up to 20 per cent below the benchmark lending rates, whereas before last week, the maximum permitted discount was just 10 per cent.
Whether this lowering of the lending rate floor will have much impact in the near term is doubtful, considering that bank analysts say that over recent months the majority of loans have been made at or above benchmark rates.
More significant is that from now on, banks will be allowed to offer deposit rates at a premium of up to 10 per cent above the benchmarks.
And that's exactly what they are doing. Despite last week's cut, China's big banks left their deposit rates unchanged, and some of the smaller ones reportedly raised their interest rates on savings deposits to the maximum level allowed.
That means, despite the official cut, a saver can now earn a nominal return of 3.58 per cent on a one-year time deposit, up from 3.5 per cent before the reduction.
Granted, this is only a small tweak to existing regulations. The compression of interest margins isn't likely to have much impact on bank earnings in the near term.
But the move is still significant. It represents the first step in eight years towards the liberalisation of China's interest rates. And liberalisation - with the market, not the government, determining deposit and lending rates - will be essential if Beijing is to achieve its aim of rebalancing the economy towards a more sustainable consumption-driven growth path.
So last Thursday's move was excellent news, just not for the reason most market watchers thought.




Right response, wrong reason, but still good news