Reasons Behind China’s Interest Cut

Published on Author taa16

China reduces interest rates for the second time in three months to 5.35% — a movement meant to stimulate the stagnating economy. Lower interest rate is feared to significantly increase borrowing and encourage businesses to take on too much debts. The central bank, however, asserts that its policy remains “prudent”. The article offers 3 arguments.

1. In China, it is the direct lending controls imposed on commercial banks rather than interest rates that determine credit growth. The overall credit growth actually have shrunk as the government has dramatically tightened the banks’ ability to lend via off-balance-sheet shadow vehicles.



2. Real funding costs indeed has increased due to a sharp drop in inflation. The average of consumer price inflation has fallen. Cutting interest rates, therefore, is meant to restore them to more reasonable levels rather than an outright easing.



3.  The Chinese government is determined to avoid a repeat of the credit binge of 2009. Local governments, state-owned enterprises and banks still struggle to handle their existing liabilities and are unlikely to take on far more debt. Statistically, China’s overall debt load (public and private) has reached roughly 250% of GDP, up 100 percentage points in five years.

This article also suggests a fiscal policy might be an alternative to a monetary policy by raising deficit to 3% of GDP rather than the aimed 2.1%.


2 Responses to Reasons Behind China’s Interest Cut

  1. In the context of my earlier post on the growth of “shadow banking” in China, it seems as though continually cutting interest rates may lead to even greater credit risk throughout China’s financial system (independent of their efforts to regulate lending). In the U.S. the growth of the relatively unregulated shadow banking sector contributed to the 2008 financial crisis, and China may be forced to deal with similar issues going forward.

  2. The distinction between nominal and real interest rates is useful; I’ve not seen that made in any of the earlier posts on money & banking issues. Nor have I made that point in my comments.

    I do add an additional point in my coments: institution constraints due to the orientation of banks towards large borrowers. Small firms remain largely unbanked.