Post 25 bps cut, tight ropewalk for China ahead: IHS Global

A deepening global crisis saw the Peoples Bank of China (PBoC) delivering a surprising 25 basis points rate cut. The one-year borrowing rate is now at 6.31% and the one-year deposit rate is at 3.25%.

The move seems to have confounded many economists and market watchers who thought the central bank would refrain from cutting policy rates this year even though policymakers had voiced the need to support growth.
Todd Lee, chief China economist, IHS Global Insight says any further monetary easing will depend on the severity of the situation. He says China’s monetary system is such that the credit expansion and the speed of that expansion are not as sensitive to the level of interest rates.
If the deceleration becomes much worse than they are expecting you can expect more cuts, he adds. Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more. Q: This is a surprise move. Were you expecting a 25 bps cut coming this early??
A: It’s a surprise in a sense that they have been relying solely on the reserve requirement ratio (RRR) cuts recently and more directly ordering banks to be more relaxed in issuing credit. So it’s clear that they are becoming increasingly concerned with a downturn. Q: You have mentioned in a note that’s been put out by IHS that this means the government is officially entering a full-blown monetary easing cycle. Are you expecting more frequent rate cuts in the months to come? How frequent and how deep do you think the cuts will go?
A: That remains to be seen because China’s monetary system is such that the credit expansion and the speed of that expansion are not as sensitive to the level of interest rates. So they could very well pump a lot of liquidity into the system without cutting rates a lot. That has more of a psychological effect. I guess depending on how severe the situation is, if the deceleration becomes much worse than they are expecting you can expect more cuts. Q: Are you saying that the manufacturing output data we are expecting on Saturday, all of that will give us a hint as to whether we can expect further rate cuts or whether they might go back to reserve ratio cuts?
A: Yes, that will be the first wave of signs to come. What they are worried about now is that this time around they are being squeezed, not just externally like in the 2009 global recession; they are also facing a domestic downturn in the housing bubble correction. That’s why the nature of their concern is a little bit different this time. Q: What do you make of the liberalisation move that was announced today, banks being able to set deposit rates higher than the benchmark rate and at a deeper discount to the loan rate?
A: I think they want to allow more flexibility in terms of providing lower loan rates especially to the private firms. China’s public still rely heavily on banks deposits as their saving of choice because the investment options in China is relatively more limited because of the under development of its financial market. So by cutting deposit rates, they are removing income away. So, they want to make sure that the rate cut does not hurt the public as much. Q: The IHS note points to the fiscal stimuli measures announced on May 16, including a subsidy programme for energy saving home alliances, faster project approval by the national development and reform commission, a higher number of projects approved in May in terms of investment size as oppose to April. This combined with let’s say this rate cut, do you think that China is making the right moves to maybe get growth back on track? Are they likely to succeed or are we going to have to see a lot more action both on the fiscal and monetary side before they are able to address the growth situation?
A: In terms of the availability of their arsenal, they are definitely in a better position than other governments. The other factor in their fight against this downturn is that because the government has control of the banks, so the type of credit freeze that we saw in the West is not likely in China.
So it’s much easier for them to push a button in releasing credit, but the issue for them is that the last time that they did that it created not only a credit bubble, but a housing bubble. So they are still in the process of trying to correct that and digest that. In that sense, the room for them to maneuver is a little bit more limited than in 2009-2010.