China analysis: interest rate cut raises fresh questions

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BEIJING – China’s move to cut interest rates for the fifth time in nine months to salve a steep sharemarket rout provides an adrenaline shot to roiling world markets, but may well underline the deepening concerns over its slowing economy.

The immediate reaction on Wall Street and in major European markets was positive, with commodity prices and the Australian dollar also given a boost.

But the question for investors is whether the nature and timing of the cuts will deliver a sustained boost to the economy, or further hurt confidence in the Chinese leadership’s economic credentials.

There are questions as to why the People’s Bank of China waited until Tuesday to act, after two days of steep losses. Investors had expected the bank to cut rates or reserve requirements over the weekend after market confidence had been sapped by a string of poor economic data. The inaction was seen to have contributed to the magnitude of the “Black Monday” wipeout, which saw shares retreat 8.5 per cent.

“Clearly, this is targeted at the falling stock market,” Tao Dong, an economist at Credit Suisse, said. “China needs extra liquidity to prevent systemic risks. But ultimately, fixing the economy is more important than fixing the stock market and advancing reforms is critical.”

The central bank announced the 25 basis points cut on Tuesday evening, hours after a 7.6 per cent plunge on the benchmark Hangzhou Composite took the gauge’s losses to 22 per cent in four days – the worst of run of losses since 1996.

The bank also lowered the amount of cash banks must set aside, known as the reserve requirement ratio, by 50 basis points. It also dropped a key control on rates for some bank deposits, allowing for greater competition among lenders.

The moves will likely be seen as reactive rather than proactive. Worse, it may be interpreted as an admission that the economic situation is direr than previously thought, coming so soon after a devaluation of its currency.

There are questions too over how much of the released liquidity – estimated in the vicinity of $US100 billion – would make its way into its equity markets with investor panic already taking hold.

And the cuts fall short of the emergency intervention in June and July, which saw a $US400 billion fund to buy blue-chip stocks and a ban on major shareholders and state-owned enterprises from selling shares.

Those unprecedented measures failed to stem a more than $US4.5 trillion rout in shareholder value since June, and authorities have signalled plans to wind back the state-backed support in the market. But public anger also dictates that the central leadership must not be seen to be doing nothing.

In a statement explaining its decision, the central bank said China’s economic growth faced “downward pressure” and that the task of stabilising growth, advancing reforms while minimising risks was proving “extremely arduous”.

It referred to volatility on global financial markets as a key reason for its move to further ease monetary policy, without specifically mentioning the sharp falls on China’s domestic exchanges.

The language mirrored that of Premier Li Keqiang, who was quoted by state broadcaster CCTV on Tuesday night as telling a visiting Kazakh delegation in Beijing that the global economic situation was complex with “large market fluctuations” which “also had some impact on the Chinese economy”.

But China’s economic fundamentals had not changed, he said.