China Faces Contrarian Calls for a Surprise Interest Rate Cut

China’s central bank is facing mounting calls to cut interest rates as fresh coronavirus outbreaks threaten to upend the recovery in the world’s second-largest economy.

Economists affiliated with the government see scope for lower interest rates, arguing that Beijing’s success in curbing debt growth means the central bank can ease policy without fueling financial risks. Their views contrast with global investment banks, who mostly see the People’s Bank of China keeping policy interest rates steady this year.​

China Faces Contrarian Calls for a Surprise Interest Rate Cut

Xu Hongcai, deputy director of the economic policy committee at the state-run think tank China Association of Policy Science, argues Beijing’s tightening regulations mean looser monetary policy “won’t create a huge risk or lead to a significant rise in property prices.”

Zhang Bin of the government-affiliated think tank Chinese Academy of Social Sciences said the clampdown on so-called “hidden” or off-balance sheet debt held by local governments has reduced Beijing’s fiscal firepower, meaning a greater role is needed for monetary policy to support growth.​

A reduction to any of the PBOC’s policy rates would be a decisive easing move that would go a step further than the surprise cut to the reserve requirement ratio last month.

The PBOC has denied the RRR cut meant a shift into broader easing, but markets have started pricing in lower rates, fueling a rally in government bond prices.

Liquidity Operation

The next window on the central bank’s thinking will be provided by 700 billion yuan ($108 billion) of one-year loans to banks maturing next week. Market strategists are taking the PBOC at its word: all but one of 11 surveyed by Bloomberg forecast no change in interest rates offered on the loans.

Most just expect the central bank will reduce the amount of that lending to offset some of the liquidity provided by the reserve requirement cut.

“The impact of the RRR cut is still being felt so there’s no need for a full rollover,” said Tommy Xie, head of Greater China research at Oversea-Chinese Banking Corp. There’s no urgency to cut interest rates as funding costs for the real economy have been declining, though another RRR cut is possible to help support small to medium enterprises, he added.

PBOC’s main policy interest rates to watch
  • Seven-day reverse repurchase: set daily, it’s been unchanged at 2.2% since March 2020
  • Medium-term lending facility: set at a monthly liquidity operation, the one-year rate has been unchanged at 2.95% since April 2020
  • Loan prime rate: the MLF rates serve as a basis for the loan prime rate, which is the de facto benchmark rate for new bank loans

When deciding key policy rates at which it lends to banks, the PBOC juggles three competing mandates: price and currency stability, supporting economic growth, and financial stability. Since 2017 the bank has become more hawkish as it increased emphasis on the stability goal, trying to limit the overall amount of debt in the economy, especially in property, shadow banking and off-balance sheet local government debt.

The PBOC abandoned that campaign briefly to offset the pandemic, before resuming it late last year as it began winding back its stimulus and curbing credit growth in the economy.

Now it’s facing calls to shift that stance again given the threat to China’s recovery coming from a surge in virus cases linked to the fast-spreading delta variant. Some investment banks including Goldman Sachs Group Inc. have lowered their growth estimates for the third quarter and full year.

CASS’s Zhang urged officials to take strong action.

“We should lower interest rates as soon as possible, and the magnitude should be relatively big,” he said in a speech in late July. He was speaking at an event hosted by a think tank run by China’s State Council, which oversees the PBOC.

Underlying the argument for lower interest rates is the fact that many government-linked economists see less of a conflict between supporting economic growth and financial stability than before. Debt control efforts have been a success, they say, and the PBOC can lower key policy rates to encourage companies and local governments to borrow and invest, while still preventing credit flowing to risky sectors, like real estate.

Latest data show how the deleveraging campaign has transformed the structure of lending: growth of outstanding property-related loans was the slowest in eight years in the second quarter, while shadow banking assets have shrunk markedly as a proportion of new credit.

Credit data for July released late Wednesday also showed a marked slowdown.

China Faces Contrarian Calls for a Surprise Interest Rate Cut

Inflation doesn’t seem to be a constraint on the PBOC either, with consumer price growth well below the government’s target of around 3%. The surge in producer prices is also transitory, the bank said in its latest monetary policy report this week.

Another argument for lower rates is to bolster corporate investment growth, which had been sluggish even before the delta outbreak. Rising commodity prices have squeezed profitability for many companies, while the financing environment for private firms worsened last month, according to a Cheung Kong Graduate School of Business survey.

“We have to cut interest rates and the reserve requirement ratio, because only then investment can be boosted and the economic momentum will be lifted,” said Cao Heping, an economics professor at Peking University.

©2021 Bloomberg L.P.

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