China Hacks At Rates

China Hacks At Rates

Parmy Olson

Beijing sharply cuts interest rates to aid the country's faltering economy.

• World Bank: China Needs Balanced Development
• Beijing's Confidence Game
• China Cooling Too Quickly

China Hacks At Rates

Parmy Olson, 11.26.08, 11:50 AM EST

Beijing sharply cut interest rates to aid the country's faltering economy.

China is scrambling to prop up its economy. The People's Bank of China made a 108-basis-point cut to interest rates on Wednesday after the markets closed, accelerating its recent policy of monetary loosening in the face of slowing exports and industrial production.

Though a rate cut was expected by the central bank, its magnitude--the largest since the Asian financial crisis in October 1997--was surprising. "Bottom line is the Chinese authorities think the economy is slowing down fast," said Nigel Rendell, a senior emerging market strategist at RBC Capital Markets. "It would not be unusual to cut by around 25 basis points--to do more than four times that highlights the downside risks."

Commodities firmed up on expectations of stronger demand from China, following the lowering of interest rates. Crude futures jumped $2.24, to $53.01 a barrel, on the Nymex; copper futures were up 6 cents, at $1.7140 a pound.

Earlier this week, the World Bank cut its forecast for economic growth in China to 7.5%, from 9.2%, though many economists expect an even slower rate of expansion, of anywhere between 2.0% and 7.0%.

This is the fourth time in three months that Beijing has reduced Chinese interest rates, but the several prior reductions, in October and August, were by just 27 basis points each time. China's benchmark rate now stands at 2.52%. The central bank also lowered its reserve requirements by 200 basis points for large banks and by 100 basis points for smaller banks on Wednesday.

The government has meanwhile been shifting fiscal gears as well, announcing on Nov. 9 a $586.0 billion fiscal stimulus plan. China is keenly monitoring the economic moves made by its key export partner, the United States, where consumer spending has recently slowed. (See "Americans Earn More, Spend Less.") Exports represented 37.1% of China's nominal gross domestic product in 2007. "I think China is looking at what's happening to consumers in the U.S. and what is likely to happen in the coming months," said Rendell. "They see house prices down, equity prices down and people being made unemployed."

China's economy is also still feeling the impact of previous measures that Beijing made to cool the economy and keep a lid on inflation; it was tightening monetary policy in the first half of this year, when the economy appeared to be growing too quickly. But in October, a lower than expected level of imports for the month showed that China was not picking up the slack from slowing economies elsewhere. (See "China's Disquieting Trade Surplus.")

China's currency actually strengthened slightly after the rate cut: the U.S. dollar bought 6.82 yuan late Wednesday in Beijing, down from the 6.83 yuan it bought on Thursday.

Rendell expects the currency to stay between 6.80 and 6.90 against the dollar, which is the range around which it has hovered since June. If exports suffered more markedly, the analyst said Beijing might let the yuan weaken further in 2009. But, given that China still has a notable current account deficit, there would undoubtedly be strong international pressure to keep it from going down that route any time soon, which would put struggling exporters in the West at a disadvantage.