Should the PBOC cut interest rates in China to aid slowing economy?

A decision on cutting interest rates in China weighs the need to bolster the slowing economy with the objectives of curtailing the debt build-up and preventing a slump in the currency.

After still-more disappointing economic data and fog around the trade war with the US, investors are upping their bets that more stimulus is on the way.

The People’s Bank of China (PBOC) could reduce the one-year lending rate, sending borrowing costs lower across the economy, or focus on driving down interbank lending rates through reverse repurchase agreements.

Among economists surveyed by Bloomberg, the consensus forecast sees the benchmark one-year rate remaining on hold for at least the next year, but a debate is raging.

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The argument that China needs more aggressive stimulus measures is gaining pace, as many economic indicators hover at multi-year lows in spite of earlier easing.

Ming Ming from Citic Securities and Lu Zhengwei from Industrial Bank say a cut in the benchmark rate or the open market operation rates is needed to encourage credit and lower funding costs.

Goldman Sachs have said they expect interbank rates to be managed lower to help growth recover.

External pressure preventing much looser policy is declining, particularly amid signs that the US Federal Reserve is turning more dovish.

An easing of downward pressure on the yuan, which has declined about 6 per cent this year, would mean much greater room for policymakers to cut the cost of borrowing without fear of accelerated declines or even capital flight.

The yuan strengthened against the dollar slightly last month, the first monthly appreciation since March.

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The PBOC also seems to be acquiescing in lower borrowing costs. Since December, the seven-day repo rate has stayed around, and sometimes below, the central bank’s seven-day reverse repurchase rate.

That means the interbank rate is close to its bottom – a further decline in the cost would require a rate reduction.

There is a but. Room for rate cuts is still limited, as top leaders still see a long-running financial clean-up as one of their policy priorities – and lower borrowing costs fly in the face of that.

Morgan Stanley economists, including chief China economist Robin Xing, say China is in a different kind of easing cycle, focusing more on private sector and fiscal stimulus, and economists from China International Capital Corp say rate cuts are not the most appropriate approach to guide the effective funding cost lower.

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“Cutting benchmark rates may not shore up the economy and could still cause other problems like further inflation of the property bubble, increasing capital flight and worsening income distribution,” Lu Ting, chief China economist at Nomura International, wrote in a recent report.

And while cutting the one-year rate may be powerful, it would set back China’s transition to a system where it is short-term market rates that count.