The Beijing-based People’s Bank of China (PBOC) announced on Tuesday that the benchmark rate for a one-year lending will be cut by 0.25 percent to 4.6 percent effective Wednesday, while the one-year deposit rate will fall a quarter of a percentage point to 1.75 percent. China’s central bank also reduced reserve requirement ratio by 0.5 percent to cover funding gaps, effective on September 6. The reserve cuts are meant to ensure enough liquidity and stable credit growth. The move came as China’s main stock index, Shanghai Composite plunged 7.6 percent at 2,964.97 points, bringing the two-day losses to more than 15 percent. Monday’s falloff had a considerable impact on the American markets as well, which seem to be closely linked to the Chinese misfortune.
China has already taken several damage-control measures to control the crisis which panicked investors around the world. The government gave billions to big brokerage firms to buy stocks and urged company executives to halt trading in their shares. They also ordered company executives not to sell their shares. New stock listings were also suspended. Economists were expecting Beijing to act, after the turmoil drove other Asian indexes to three-year lows and knocked European markets off by as much as 5 percent. On Wall Street, the Dow Jones industrial average slid by more than 1,000 points, just minutes after the opening bell rang. Some of the biggest US companies have shed billions of dollars in market value in only a few days. The massive selloff has been partly blamed on China’s inaction over the weekend.
“The government has stopped using unconventional intervention in the stock market and decided to use more traditional and more market-based methods to boost market momentum and help the real economy,” said Lu Ting, chief economist at Huatai Securities Co. “Beijing has released some positive signals and these will help global stock markets. Using monetary easing to drive stocks and the economy is a method more acceptable to international capital markets.”
The PBOC has overwhelmingly intervened on the exchange markets to defend the yuan, drawing down reserves at a blistering rate. The yuan may face more downside pressure as a result of the latest monetary easing, following China’s surprise currency devaluation on August 11. China’s currency has been on the edge for a decade, during which the yuan gained importance globally and the economy grew to be the second largest in the world. Global markets plunged after the depreciation, with emerging market currencies and commodities among the worst hit. Investors are now moving their money out of the country seeking better returns elsewhere, especially at a time when China is struggling with deflation and falling prices in its industrial sector.
The PBOC said that the move was to reduce “the social cost of financing to promote and support the sustainable and healthy developments of the real economy.” The move was broadly welcomed by economists. It also promised to pay close attention to liquidity, or the availability of credit, a possible attempt to ease concern that a recent rise in capital outflows from China might leave less money for lending. Injecting more funds should help soften the blow and stem capital outflows. But the latest measures alone may not be enough to add any sustainable boost to the economy. The Chinese authorities, however, hope the latest move will be enough to calm markets before the full effects of growing credit feed through to the real economy. Whether the latest interest rate cut will do the trick is entirely a different story.