Understanding China's 'surprise' rate cut

China's decision on Nov 21to reduce the interest rates is a surprise to many, as top policymakers had previously insisted on staying away from all-round rates moves.

Before this round of rates cut, the government maintain resorted to "targeted and selected" monetary loosening policies to bolster economic growth. What it did was to reduce the required reserve ratios for rural lenders and selected city commercial banks, as well as use short-term financial tools to boost liquidity.

The rate cut hence prompts speculations that the central government has given up the tight stance to embark on a loosening path.

But I would beg to differ.

The rate cut was definitely a response to recent signs of a deep slowdown, but it aims more to provide a better foundation for next year's reform instead of merely shoring up the economic growth.

Entering the fourth quarter, the Chinese economy showed more signs of slackening.

In October, sales of social consumer goods rose 11.5 percent year-on-year, the slowest pace this year. The purchasing managers index stood at 50 in November, showing manufacturing activities are nearing a contraction.

Three other major economic indicators - which are closely watched by Premier Li Keqiang as barometers of how the economy is doing - turned worse in October.

Freight volume came at 3.89 billion metric tons, a rise of 4.8 percent, significantly lower than the year's average of 7.3 percent.

Electricity consumption was 450.8 billion kWhs, increasing 3.1 percent, compared with the average of 3.8 percent.

Credit growth also slowed down, as M2, the broad measure of money supply, jumped 12.6 percent at the end of October. The increase was 1.7 percentage points lower than a year ago.

Clearly, the economy is turning worse and has a big chance to be even slower than 7.3 percent in the third quarter. As the central government has pledged to achieve yearly economic growth of around 7.5 percent, it needs to fulfill that promise.

The rate cut was partly to meet that purpose. If the government lowers the growth rate to 7 percent next year, it may not need to resort to all-round rate cut to spur the economy like what it did this time.

In addition, this round of rate cut can be a one-time policy boon for local governments in a tradeoff for more reforms next year.

This can be seen by the margin of the rate cut.

The central bank last week cut the benchmark lending rate by 40 basis points. Previously, the bank usually cut the rate by 25 basis points. Moreover, the benchmark deposit rate this time was reduced by only 25 basis points, smaller than the reduction of the benchmark lending rate. The asymmetric rate cuts were rare.

So generous a rate cut could mean the next round of all-round loosening may not come so soon if it really comes.

In this sense, it is too early to say all-round loosening has become a normalcy.

The author is a Shanghai-based analyst.