The Finer Details of Interest

　　Facing deflation risks and slower economic growth， China’s central bank may continue cutting interest rates and reserve requirement ratios

　　Three months after the previous rate cut， the People’s Bank of China (PBC)， the country’s central bank， slashed benchmark interest rates by 0.25 percentage points on March 1， bringing the one-year benchmark lending rate to 5.35 percent and one-year benchmark deposit rate to 2.5 percent. The PBC also lifted the deposit rate ceiling from 1.2 times the benchmark rate to 1.3 times to further promote interest rate liberalization.

　　The PBC said in a statement that the focus of the rate cut this time is allowing benchmark rates to continue to guide market rates， further lower financing costs and provide a neutral monetary environment for economic restructuring， transformation and upgrading.

　　On February 5， the PBC cut the reserve requirement ratio (RRR) for all financial institutions by 0.5 percentage points， and on November 22， 2014， the central bank cut the benchmark rate for deposits by 0.25 percentage points to 2.75 percent， and the one-year lending rate by 0.4 percentage points to 5.6 percent.

　　“Affected by accelerated economic restructuring and the remarkable decline of bulk commodities in the international market， the growth rate of the consumer price index (CPI) has fallen， and the producer price index has continued to decline in recent months， pushing up the real interest rate，” said the PBC in a statement released alongside the rate cut. “Currently consumer price growth is at a record low， providing space for the interest rate adjustment.”

　　From the market’s perspective， the rate cut has been a long-time coming， because it is an inevitable choice when the economic growth is slowing down and deflation is emerging. Liu Dongliang， a senior analyst with the Financial Market Department of China Merchants Bank， said that， when the economic growth further slows down， the central bank must accelerate easing the monetary policy. If the rate cut comes too late， the economy is likely to stall. Moreover， reducing the interest rate can better stimulate credit growth than an RRR cut will do.

　　When cutting the interest rates， the central bank has also lifted the deposit rate ceiling from 1.2 times the benchmark rate to 1.3 times. Right after the PBC’s announcement， Evergrowing Bank， one of the 12 national joint-stock commercial banks， decided to raise its deposit interest rates to 130 percent of the benchmark interest rate of the central bank.

　　Lou Lili， General Manager of the Department of Strategy and Innovation of Evergrowing Bank Co. Ltd.， said the central bank is accelerating interest rate liberalization， so commercial banks must respond actively.

　　Yang Chi， head of the Strategy Office of Huaxia Bank’s Department of Development Studies， told Economic Information Daily that the trend of differential pricing for deposits will be more prominent， and more commercial banks will not be raising their interest rates to the ceiling； rather， they will adopt a flexible pricing strategy considering their own borrowing costs and client structures.

　　More cuts to follow

　　The PBC said in the news release that it will focus on keeping interest rates in line with trends in economic growth， consumer prices and employment. However， this does not mean the prudent monetary stance will be changed.

　　The central bank has stressed that it will maintain the continuity and stability of policies and continue to implement a prudent monetary policy. It will use diversified monetary policy tools and make appropriate preset or fine adjustments at a proper time so as to provide a neutral monetary environment for economic restructuring， transformation and upgrading. It will also promote sustainable economic growth.

　　Gao Yuwei， a research fellow with the Institute of International Finance under the Bank of China， said the rate cut this time indicates again that the “prudent” monetary policy should not only be understood literally. In fact， the monetary policy will be “gradually relaxed” this year and Gao estimated that the broad money supply (M2) will grow by 12.5 percent by the end of 2015， 0.3 percentage points higher than that in 2014.

　　Interest rate cuts may continue this year. According to Jia Shupei， an analyst with the Research Department of China Credit Rating Co. Ltd.， considering a low inflation rate at the beginning of this year (which was 0.8 percent in January) and weak domestic demand， China Credit Rating Co. Ltd. has lowered its expected CPI growth for 2015 to 1.3 percent， which will be 0.7 percentage points lower than last year. “So， a lending rate that is 0.5 percentage points lower than the current level will be equivalent to the real interest rate last year，” said Jia.

　　More RRR cuts will follow. A report by China International Capital Corp. Ltd. said interest rate cuts are still not enough， and more resolute RRR cuts are needed to address the capital outflow caused by currency depreciation. If the central bank does not input more liquidity by lowering the RRR， the market will face a shortage of capital. The central bank must actively guide the money market rate to drop so as to bring down the borrowing costs of banks， and then the overall interest rate will come down. Only when the money market rate falls significantly can the economic growth steady.

　　A policy mix

　　Since last year， monetary policy has been functioning to ensure stable growth and accelerate economic restructuring through tools such as targeted RRR cuts， pledged supplementary lending， medium-term lending facility， overall interest rate cut and overall RRR cut.

　　However， macroeconomic control must rely on both monetary policy and fiscal policy. Particularly， fiscal policy will be more effective in addressing some structural problems.

　　“The recent economic performance shows that marginal effect of monetary policy is decreasing， so we should not only rely on rate cuts to ensure stable economic growth，” said Yang. “Currently， affected by shadow banking and Internet financing， the banking system faces an increasing outflow of capital. Market interest rate hikes make banks and companies victims of high borrowing costs， and the room for banks to lower loan rates is limited.”

　　According to Yang， the PBC lowered the benchmark lending rate by 0.4 percentage points in November 2014. However， the loan prime rate， which reflects the real interest rate in the market， only dropped by 0.25 percentage points from 5.76 percent to 5.51 percent as of February 28.

　　While the appropriately “relaxed” monetary policy will continue， he expects a more relaxed fiscal policy will play a bigger role， where a tax cut is likely to replace expenditure expansion to be a more powerful tool of fiscal policy. Tax burden of small and medium-sized enterprises will be further alleviated， and taxes for real-estate transactions may be reduced or exempted.

　　According to a report from Minsheng Securities’ Research Institute， proactive fiscal policy will include making good use of the government’s fiscal resources and nurturing new growth points such as public facilities in the countryside， subway facilities in urban areas， healthcare， preschool education， culture and entertainment， sports， e-commerce and environmental protection.

　　Xie Yaxuan， an analyst with China Merchants Securities， said that in the future， both fiscal policy and monetary policy may be relaxed， but the relaxed fiscal policy will be different from before. The Central Government will take on the burden of more expenditure， leaving local governments with larger budgets， and such increases will be restricted by the budget.

　　By Wang Jun