China's central bank cuts interest rates

Beijing-China (Jun 27)   After more than a week of a brutal selloff in Chinese stocks, the country's central bank on Saturday took a rare easing step, cutting both its benchmark interest rates and the amount of reserves certain banks are required to hold.

In a statement, the People's Bank of China said both steps were aimed at lowering borrowing costs and helping "stabilizing growth" in the world's second-largest economy.

The PBOC cut its one-year benchmark lending rate by a quarter of a percentage point to 4.85% and its one-year deposit rate by the same scale to 2%.

At the same time, it also lowered the reserve requirement by half a percentage point for banks with sizable lending to farmers and small businesses.

The central bank has rarely cut both interest rates and the reserve-requirement ratio on the same day. The last time it did so was in October 2008, the height of the global financial crisis.

The actions came a day after Chinese stocks saw their biggest one-day decline in several years. On Friday, the Shanghai Composite Index fell 7.4% and was off 19% since hitting a 52-week high on June 12, a decline that has wiped away $1.25 trillion in market capitalization, an amount roughly equal to the size of Mexico's economy.

A stock-market collapse would hurt investor confidence and hurt Beijing's efforts to revamp the financial sector at a time when China is struggling with high debt levels and as the government is trying to steer the economy to one driven by private business and consumer spending, rather than infrastructure outlays and exports.

Analysts saw the PBOC's moves as a reaction to the massive stock market decline. The near-20% decline in equity values in a matter of days-- despite efforts to clamp down on margin lending--threatens to undermine recent progress on restoring growth momentum, said ING economist Tim Condon. "It's difficult when you have a tiger by the tail. The stock market is clearly fueled by speculative excess," he said.

It isn't surprising that China cut interest rates, said HSBC economist Ma Xiaoping, but what was unexpected was that Beijing would put through both a cut in benchmark interest rates and a reduction in certain bank reserves at the same time. This reflects the central bank's desire to stimulate the economy, fight deflationary pressure and respond to last week's sharp market decline, she said.

Some analysts went so far as to liken the action by PBOC to that taken by the U.S. Federal Reserve following the infamous " Black Monday"--or Oct. 19, 1987, when stock markets around the world crashed. The Fed at the time encouraged banks to continue to lend to one another on their usual terms, which boosted investor confidence in the central bank's ability to calm severe market downturns.

"It's just like what the Fed did in 1987," said Larry Hu, China economist at Macquarie Group Ltd., a Sydney-based investment bank. "The PBOC is trying to stabilize the market with the unprecedented easing moves."

Many market participants attribute the stock-market plunge to the confusing signals sent by China's central bank. On the one hand, they say, the PBOC appears to be committed to further loosening credit; on the other hand, the central bank has quietly taken steps to drain liquidity from the banking system--moves that have led some in the market to suspect a change of stance in China's monetary policy.

For the central bank, the confusion underscores a thorny issue it is struggling with after having delivered a barrage of big-bang easing steps since November: How to get Chinese banks to lend more to struggling companies while discouraging them from funneling funds to the country's increasingly speculative stock market.

A strategy being used by the central bank involves withdrawing some short-term liquidity from the banking sector while adding more longer-term funds. Officials at the central bank hope that such a two-pronged approach can help drive down longer-term interest rates and prod banks to lend more to sectors of the economy that can generate jobs, such as small and private businesses.

Last week, the central bank withdrew some 300 billion yuan ($48.4 billion) in short-term funds from the banking system by not rolling over some loans it had extended to the lenders, according to banking executives with knowledge of the action. The move was intended to prevent banks from channeling funds into the stock market by lending to brokerages, which then used the money to finance investors' purchases of stocks. Such practice is more lucrative for banks than making plain corporate loans.

But that action led to a market rout last week, as investors had expected the central bank to continue to add--not extract--liquidity from the financial system. On Thursday, in an apparent move to calm the market, the PBOC, dubbed Yang Ma, or Big Mama, in China, injected 35 billion yuan into the system by using open-market operations for the first time in two months. In a statement, the central bank said the cash injection was in response to a pickup in demand for cash from small- and medium-size lenders.

On Friday, amid the severe stock-market plunge, the central bank took another step intended to calm jittery investors: it not only rolled over 130 billion yuan of three-month loans to banks but also extended their maturity to six months and reduced the interest rates on the loans by 0.15 percentage point to 3.35%, according to people familiar with the matter. Officials at the central bank also hope the move could help drive down borrowing costs for businesses and consumers alike.

Source:  WSJ