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.
“This is a signal to Chinese banks that it’s the end of an era in which the central bank guaranteed a spread,” Lardy said. “It gives the banks greater incentive to be more commercially oriented.” Much of bank lending goes to real estate or state-owned enterprises rather than companies that might grow faster and contribute more to the economy.
But Lardy said he was “skeptical” about how much the rate cut would help the Chinese economy, which he said has become more indebted and more tied up with real estate than it was in 2008, when the previous cut took place.
Bank loans to real estate developers or mortgages amount to 25 percent of China’s GDP, Lardy said, not much below the 30 percent level for Spain’s struggling banks. Spanish real estate investment peaked in 2007 at 9.3 percent of the nation’s GDP; Chinese investment in real estate development went from 7 percent of GDP in 2008 to 9.4 percent in 2011, he added.
Meanwhile, household indebtedness has nearly tripled since 2008, Lardy said, suggesting that the demand for new homes might cool. Surveys show that many Chinese have bought second homes.
Unlike home buyers in the United States, the Chinese generally put down much more money. But, Lardy said, “property has been the key driver of economic growth for at least five years. It’s gone up and up and up.” While a real estate swoon might not pose a threat to China’s banking system or herald widespread mortgage trouble, it could deal a blow to economic growth, he said.
That worries China’s leaders. Maintaining rapid growth is as much a political imperative as an economic one, particularly with the ruling Communist Party set for a once-in-a-decade leadership transition this year. Various officials have spoken obliquely in recent days of other, unspecified measures to boost growth.
“The interest rate mechanism is only one of a number of decisive measures Beijing can take,” Rosen said. “I continue to give Beijing the benefit of doubt that they will deliver a soft landing.”
Richburg reported from Beijing, and Mufson reported from Washington.