China’s Central Bank Cuts Interest Rates to Support Weakened Economy

China’s Central Bank Takes Action Amid Economic Challenges

On Thursday, China’s central bank implemented a significant cut to a key interest rate, marking its second intervention this week aimed at countering the ongoing challenges posed by a weakening economy and a pressing housing market crisis. This unexpected move coincided with a notable decline in stock markets across much of Asia during early trading hours, mirroring Wall Street’s sharp drop the previous day.

Market indexes across Australia, Japan, South Korea, and Hong Kong experienced declines ranging from 1 to 3 percent. In contrast, share prices in Shanghai and Shenzhen saw a comparatively lighter drop. This disparity could indicate a favorable response from investors to the central bank’s rate adjustment or may suggest some level of intervention by the Chinese government, which maintains a significant presence in the nation’s stock markets.

As trading commenced in China on Thursday, the People’s Bank of China (PBOC) announced a reduction in its interest rate for one-year loans to commercial banks, lowering it from 2.5 percent to 2.3 percent. This marks the most substantial cut to this rate since a similar reduction in April 2020, a time when the Chinese economy was grappling with the ramifications of a near-total lockdown during the initial outbreak of the coronavirus pandemic.

The one-year interest rate serves as a critical benchmark for commercial banks, guiding the rates they apply to loans for corporate clients as well as to financing entities established by local governments. While Beijing restricts local governments from borrowing directly from banks, it permits them to create financial units that can engage in such borrowing.

Currently, many of these financial units are burdened with substantial debt, leading local governments to implement salary cuts for teachers and other civil servants as a measure to conserve finances.

This latest reduction in the one-year interest rate follows the central bank’s actions earlier in the week to lower other controlled rates. These measures came in the wake of a recent conclave of the Communist Party’s leadership focused on economic policy, which failed to deliver the broad course correction many economists had anticipated.

• The party reaffirmed its commitment to pursuing economic self-reliance through increased investment in high-tech industries.
• This approach indicates a reluctance to shift towards greater consumer spending.

By reducing rates now, rather than waiting for a potential cut by the U.S. Federal Reserve in the autumn, there is a risk that more Chinese companies and households may seek to transfer their money abroad in pursuit of higher interest rates elsewhere. Such a trend could further weaken the renminbi against the dollar.

Additionally, lower interest rates might reignite speculative borrowing practices that posed challenges for Beijing in the past. However, according to Eswar Prasad, a distinguished economist from Cornell University specializing in China’s monetary policy, concerns over financial risks and currency depreciation appear to be secondary at this juncture. He emphasized, “Supporting growth is taking precedence over other objectives, such as limiting financial risks or preventing currency depreciation.”