Business / Economy

China's rate cut to promote growth

(Xinhua) Updated: 2015-10-25 19:26

BEIJING - China's central bank on Friday cut interest rates and lowered the reserve requirement ratio (RRR) to promote growth and interest rate liberalization.

The People's Bank of China (PBOC) cut its benchmark one-year lending and deposit rates by 25 basis points each to 4.35 percent and 1.5 percent, from October 24. The bank also cut the RRR for all financial institutions by 50 basis points.

This is the fifth RRR reduction and the sixth round of interest cuts in the last year.

Liquidity injection

Any rate cut's direct impact on growth tends to be limited, but it reduces the interest rate burden for corporates and local governments and reduces financial risk, said a J.P. Morgan report sent to Xinhua.

"The monetary easing is supplemented by additional fiscal policy adjustment to mitigate the funding constraint faced by local governments. Local government debt swap program was expanded to 3.2 trillion yuan in 2015, and policy banks issued 300 billion yuan special financial bond to support infrastructure investment," according to J.P. Morgan.

"As the real economy faces tough challenges, the cuts in interest rates and RRR are building a sound monetary environment for stable growth," said Zeng Gang, researcher at the Chinese Academy of Social Sciences.

The move is meaningful for enterprises as they will reduce financing costs and improve operating conditions, Zeng said.

Wang Tao, a UBS economist, expects the PBOC to cut rates one more time this year, and again in early 2016 to bring the one-year deposit rate to 1 percent and the lending rate to 3.85 percent.

"This would push the real deposit rate into negative territory, as often happened in the past, which could encourage consumption, support asset prices and anchor inflation expectations," said Wang.

Interest rate liberalization

As a step towards full interest rate liberalization, the central bank also announced on Friday removal of the 50 percent upper-bound for deposit rates, in principle leaving banks free to set their own deposit rates.

The removal of the deposit rate ceiling completes interest rate liberalization, though it will take longer for rates to be fully determined by market, said Wang.

To that end, Wang suggests breaking implicit credit guarantees, reforms of SOEs and financial sectors, and a more price-based monetary policy.

Helping internationalization of RMB?

The rate move came after deputy PBOC governor Yi Gang's remarks at the IMF annual talks in Lima last week that China hopes the RMB will be included in the special drawing rights (SDR) basket later this year.

The PBOC issued its first offshore RMB note in London on Wednesday,worth 5 billion yuan at a rate of 3.1 percent, due in 2016. It has also extended an agreement on a reciprocal currency swap scheme with the Bank of England.

The PBOC opened the onshore inter-bank FX market to foreign central banks, sovereign wealth funds and multilateral financial institutions on Sept 30. Paul Mackel, head of EM FX strategy at HSBC, described the PBOC activity as addressing "some" of the IMF's initial considerations for the next SDR review.

"There have also been several other announcements that are not directly targeted at the upcoming SDR review, but are nevertheless supportive of the RMB playing a more important global role over the medium term, be it in asset management, the invoicing of goods and services trade, FX trading, or as a funding currency," Mackel said in a report.

Earlier this month, the first phase of the China international payment system was launched in Shanghai. Also on Oct 8, the central bank announced that China's official statistics will conform to special data dissemination standards (SDDS), an IMF statistical system to improve transparency.

On October 6, SWIFT said that the RMB overtook the Japanese yen in August to become the world's fourth most important payment currency.

The SDR is currently made up of the dollar, euro, Japanese yen and the British pound. The yuan failed to be included in 2010 when the IMF said the currency did not meet the "freely usable" criteria.

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