China’s central bank cuts interest rates to spur economy

Chinese policymakers cut benchmark interest rates and reduce reserve ratio to stimulate country’s fragile economy

Photo by: Reuters
Photo by: Reuters

The People's Bank of China

China's central bank cut interest rates and lowered the amount of reserves banks must hold for the second time in two months on Tuesday, ratcheting up support for a stuttering economy and a plunging stock market that has sent shockwaves around the globe.

The moves came after Chinese stocks tumbled again on Tuesday, as investors despaired at the lack of policy action from Beijing in response to recent data suggesting the downturn in the world's second-largest economy was deepening.

The People's Bank of China (PBOC) said it was cutting the one-year benchmark bank lending rate by 25 basis points to 4.6 percent, cutting one-year benchmark deposit rates by the same amount, and reducing reserve requirements (RRR) by 50 basis points to 18 percent for most big banks.

Major Chinese stock indexes nosedived more than 7 percent on Tuesday, hitting their lowest levels since December, following a more than 8 percent plunge on Monday.

The plunge had resumed last week despite Beijing's efforts to arrest a 30 percent crash earlier in the summer with hundreds of billions of dollars of state-backed share purchases.

This time, the government appeared to be sitting on its hands until Tuesday's response, which aimed at shoring up economic fundamentals rather than underpinning stocks.

"Although this has some elements of giving comfort to the market, this is more about giving a real boost to the real economy so the government can continue to have its 7 percent growth rate fulfilled," said Liu Li-Gang, China economist at ANZ Bank in Hong Kong.

Liu said the RRR cut was the most significant element of the PBOC action, as it would inject 650 billion yuan ($101 billion), into the economy and ease concerns of a "hard landing."

China, one of the main engines of the world economy, has overtaken Greece at the top of the worry list of global investors, who fret its economy is growing at a much slower pace than the official 7 percent target for 2015.

Futures limit down

The CSI300 index .CSI300 of the largest listed companies in Shanghai and Shenzhen dropped 7.1 percent on Tuesday, while the Shanghai Composite Index .SSEC fell 7.6 percent to close below the psychologically significant 3,000-point level.

Underscoring the panic gripping the retail investors who dominate China's stock markets, all index futures contracts fell by the maximum 10 percent daily limit, pointing to expectations of even deeper losses.

Though the PBOC move came after domestic markets had closed, stock markets in Europe jumped, and US stock futures were also given a lift.

After the turmoil in China rocked world equity and commodity markets on Monday, policymakers elsewhere in Asia sought to soothe fears about the broader impact on the global economy.

"I think it's important that people don't hyperventilate about these types of things," said Australian Prime Minister Tony Abbott, whose country is heavily exposed to China, the biggest consumer of its commodity exports.

"It is not unusual to see stock market corrections. It is not unusual to see bubbles burst in particular markets and for there to be some flow-on effect in other stock markets, but the fundamentals are sound."

This week's steep declines have taken Chinese stocks into negative territory for the year to date, although Leland Miller, president of China Beige Book International, pointed out that Chinese equity markets have shown little correlation with the real economy - either on the way up or the way down.

"Previous boom-bust cycles in Chinese stocks have also shown little or no connection to [apparent] economic performance," said Miller, whose firm provides anecdotal survey information about China based on the Fed's "Beige Book" model.

No rescue?

While there is little evidence that the stock market mayhem has dampened consumer spending so far, concerns about the economy intensified after factory activity shrank at its fastest pace in almost 6-1/2 years and the central bank unexpectedly devalued its yuan currency earlier this month.

A majority of analysts, however, predict a continued deceleration - rather than a crash - for China's economy, and dismiss comparisons with the 2008 Global Financial Crisis or the 1997/98 crisis in Asia.

"The current panic is essentially 'made in China'. The recent data from other major economies have generally been good and there is little to justify fears of a major global downturn," wrote economists at Capital Economics.

"China's recent economic data suggest that growth remains sluggish, but are not weak enough to justify fears of a hard landing."

Some companies, too, have sought to reassure investors that China's economy is not about to go over the cliff, with Apple Inc Chief Executive Tim Cook and planemaker Boeing Co making encouraging noises about China on Tuesday.