In its first rate cut since the depths of the global financial crisis in December 2008, the People’s Bank of China lowered the interest rate on a one-year loan by a quarter percentage point to 6.31 percent, effective Friday.
On the news, the Dow Jones industrial average rose as much as 140 points but then faded in afternoon trading to close up 46 points.
Chinese economic authorities have resisted pressure in the past to lower rates, opting instead for strong fiscal stimulus measures. Since the last rate cut, the central bank has raised rates five times to soak up excess liquidity and damp inflation pressures.
“This is important signaling,” said Daniel Rosen, a partner in the Rhodium Group, a New York-based advisory firm. “A quarter-percent rate cut will punch above its weight in impact on confidence and private investment because it indicates that the government is ready to turn a corner on its reluctance to use rates to confront slowing growth.”
Rosen said Chinese authorities have been torn between the need to damp hot real estate markets by keeping rates high and the political need to boost the economy.
During the past four years, however, the banking sector’s reliance on real estate loans has increased sharply and public spending on infrastructure has become increasingly wasteful, many economists say. The government has introduced a series of subsidies to persuade Chinese consumers to buy cars and energy-efficient appliances, but consumer spending amounts to only about one-third of China’s gross domestic product, low by international standards.
Recent figures show that China’s breakneck economic growth of recent years has slowed. Officials say they expect the GDP growth rate to drop to 8 percent, still brisk but down from double-digit rates in the past. On May 12, to spur bank lending, regulators cut the minimum amount of reserves Chinese banks are required to hold to protect themselves in case of a crisis.
The currency crisis and economic slowdown in Europe, as well as the lackluster growth in the United States, threaten to further hurt China’s exports.
Nicholas R. Lardy, a senior fellow at the Peterson Institute of International Economics, said the Chinese central bank also announced that it would allow interest rates on deposits to float up 20 percent from the benchmark rate. That means they could fall to 3.25 percent from the current 3.5 percent.
That means, he said, that actual interest rates paid on deposits won’t change much, if at all. Instead, profit margins at Chinese banks, which Lardy called “staggeringly high,” will be reduced as they lend at lower rates. Bank profits amount to more than 2.5 percent of China’s GDP, he said.