Chinese interest rates cut - is the boom over?
By Alexander Davies | 23 Sep, 2008
In a shock announcement recently, the People’s Bank of China (PBOC), cut interest rates from 7.47% to 7.2%. Rates were widely expected to not fall until next year.
During 2007 interest rates were raised six times to try to keep inflation under control. This year, however, economic growth has slowed as overseas demand for Chinese products has decreased. This has helped ease inflation prompting the PBOC to cut rates for the first time in six years.
In addition the level of assets Chinese banks must keep as cash (the ‘reserve requirement ratio’) will be reduced by 1% to 16.5%. Lower requirements will reduce the cost of corporate borrowing.
This is a pre-emptive move by the government to reduce the effect of a worsening global credit market. In recent years China has established itself as an economic powerhouse. The government had to act now to ensure their economy continues to grow. These quick changes in China’s monetary policy show the policymakers are not afraid to adapt to a changing economic environment, act when necessary, and actively encourage further economic growth.
The Chinese economy had to slow eventually and global demand for Chinese produce is likely to continue to fall as some major western economies enter a recession. It will take time before matters improve and domestic demand will have to increase significantly to cover the shortfall. As the Chinese population has become wealthier spending has increased, but whether this is enough to fill the gap remains to be seen.
Some key drivers for the Chinese economy remain in place; namely a fast developing nation consuming huge amounts of resources. Despite short term setbacks we expect further growth from this region in the future. Over the longer term lower interest rates could provide a real boost for Chinese equities. The cost of living will reduce and demand for goods and services will rise. This could fuel growth in the economy through rising consumer spending and investment, even if foreign demand for Chinese goods continues to fall
The Shanghai A Share market has fallen more than 50% over the last year. The question is will these measures be enough to stop the market falls? When these measures were announced last Monday the market fell, but this was in line with other world markets and more likely to be influenced by the turmoil in global credit markets rather than the announcement from the PBOC. If Chinese policymakers remain willing to act when necessary the longer term benefits could be significant for investors in this higher risk emerging market.
