China’s Central Bank Rate Cuts: Too Little to Be Much Help

The headquarters of the Chinese central bank in Beijing in a file photo. Mark Ralston/AFP via Getty Images

Commentary

The People’s Bank of China (PBOC) finally cut interest rates on July 22, with the goal of helping China’s economy recover its lost momentum. While this action was first promised months ago in a series of Communist Party planning meetings, the PBOC has held off acting until now.

Though any action is welcome in the face of China’s urgent economic needs, the PBOC has offered very little with these tiny cuts. It will have to do much more to get China’s economy moving again.

Rate reductions were timid, to say the least, especially in light of the economy’s needs. The central bank announced a cut of 20 basis points (hundredths of a percentage point) in the one-year medium-term policy rate, bringing it down to 2.3 percent from 2.5 percent. It cut 10 basis points off the five-year loan rate, lowering it to 3.85 percent. It also cut 10 basis points each off the one-year prime lending rate and the seven-day reverse repo rate, bringing the former down to 3.35 percent and the latter down to 1.7 percent.

Even though policy meetings all spring—at the Two Sessions first and then the April Politburo—talked about the need for interest rate cuts to help the economy regain its momentum, these July cuts were the first since August 2023. Policymakers at the PBOC have offered no explanation as to why they waited so long to make a move, but the bank’s inaction certainly didn’t help the economy. Despite the inexplicable delays, the movement is nonetheless welcome. For that reason, media—in China and the West—have dedicated headlines to it. These rate cuts, however, are hardly worth the excitement.

China’s economic circumstances demand more—10 or 20 basis points are unlikely to have much of an effect on an economy that is clearly faltering. Still, more than that, the path of Chinese inflation raises doubts that even today’s reduced levels are stimulative at all. Consider that in early 2023, before the PBOC started cutting interest rates, Chinese consumer prices were rising at an annual rate of over 2 percent. Anyone who borrowed then would repay the loan with yuan that had about 2 percent less buying power. Since the prime lending rate in early 2023 was 3.65 percent, borrowers paid an effective real charge of only 1.65 percent on the loans. But now, Chinese consumer inflation is averaging close to 0.1 percent a year.

Borrowers get no break from the declining buying power of what they owe. The real rate of borrowing then, even after the rate reductions, is little different from the nominal rate of 3.35 percent. Effectively, the real cost of borrowing has risen, despite the nominal interest rate cuts. With inflation going down to just about zero, the PBOC would have had to cut this interest rate to 1.65 percent just to keep borrowing incentives where they were a year and a half ago. The central bank’s lack of action and piddling rate cuts have actually made Chinese monetary policy more restrictive.

Still more fundamental is the huge drop in consumer and business confidence over the past few years. With no confidence in the future, it is doubtful that individuals and businesses would borrow even if the bank had managed to cut interest rates enough to stay ahead of decelerating inflation. Households have good reason to show reservations about spending and certainly borrowing. The slowdown in China’s economy has cut into wages, and even where wages have risen, the pace is nowhere near what Chinese workers had come to expect.

Meanwhile, the property crisis has depressed residential real estate values, and since, for most Chinese, the value of their home is their primary asset, the decline has detracted markedly from people’s sense of wealth and cut into spending accordingly. The pandemic and the zero-COVID policy that followed it interrupted business so much that many Chinese have become wary about their ability to earn a regular income.

Private businesses have suffered similarly, causing them to hesitate, like households, on new spending initiatives and expansion plans. But they have been troubled by something more. Not too long ago, Xi Jinping criticized private businesses for seeking profits more earnestly than following the Communist Party’s agenda. He could not have done more to make businesses wary of spending and expansion. To be sure, Xi has changed his tune lately, but the damage has been done. Owners and managers remain reluctant to spend and certainly to borrow. Understandably, they worry that Xi might resume his former hostile attitude over the longer term.

Against such a disinflationary backdrop and the extremely low confidence levels among business and household decision-makers, it is easy to see why Beijing and the PBOC are having trouble with efforts to spur growth by inducing borrowing and spending, especially since the interest rate cuts are so timid.  Meanwhile, the Chinese economy continues to suffer.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.