Pressure for interest rate cut intensifies - expert

01/28/2002

China most likely will cut its benchmark interest rates by 25 to 50 base points by the middle of February in order to spark domestic demand in the sliding economy, experts said.

Stimulating domestic spending has become urgent ever since China's gross domestic product (GDP) growth began losing momentum in the second half of last year and a tumbling Japanese yen stunted the country's export growth, they said.

"The performance of China's economy has been very lousy recently," said Xu Hongyuan, director with the economic forecast division under the National Bureau of Statistics' State Information Centre.

Although the country registered an eye-catching 7.3 per cent GDP growth last year amid the world economic recession, growth for the four quarters of the year edged down from 8.1 per cent in the first quarter to 7.8 per cent in the second, 7 per cent in the third and only 6.5 per cent in the fourth, he said.

This downward trend signals that China's GDP growth will decline further in 2002 if there is no proper economic stimulus, Xu told Business Weekly.

Xu Hongyuan was echoed by Xu Lianzhong, a senior researcher with the information centre under the State Council.

Xu Lianzhong said the GDP growth slowdown, which started last year, damaged consumer and investor confidence and is likely to further drag down growth this year.

China's exports are unlikely to play a big role in jacking up GDP growth this year, leaving domestic spending, which might be spurred by interest rate cuts, to take the lead.

China's exports have already been hit by the sluggish world economy. The recent depreciation of the yen will add further pressure by reducing the demand for Chinese exports to Japan, which currently accounts for 17 per cent of China's exports, said Huang Yiping, chief economist with global investment bank Salomon Smith Barney's China branch.

"It also slightly reduces China's export competitiveness compared with other Asian countries if, as usual, a weak yen leads to weak currencies elsewhere in Asia," Huang added.

Director Xu Hongyuan echoed Huang's view, saying that continued depreciation of the yen could trigger a new financial crisis in Asia, and China needs to take forceful measures to shore up internal demand when external demand remains weak.

George Leung, chief economist with the Hongkong and Shanghai Banking Corp Group China , said China would have to go through a transitional period in the next five to 10 years, during which the powerhouse of China's GDP growth will shift from exports to internal demand.

Experts also said the current interest rate level and the re-emergence of deflation in China have created space for a cut in renminbi interest rates.

China has not followed the global trend of slashing interest rates in the wake of the global downward spiral. China last cut its interest rates in June 1999.

The benchmark one-year renminbi depository rate stands 2.25 per cent right now, but actual interest rates are higher when deflation is taken into account.

The consumer price index (CPI) of last December stood at minus 0.3 per cent, confirming that price deflation, which had been phased out in mid-2000, has returned to China again, said Huang.

The minus 0.3 per cent CPI figure last December means China's real one-year interest rate actually stands at 2.55 per cent, which is high not only internationally, but also domestically when compared to the past several years, said Xu Hongyuan.

SSB's Huang said China's real interest rates are inching towards 5 per cent, a level not seen since 1999.

"High real interest rates usually encourage saving and discourage consumption and investment. They will thus exacerbate the condition of the economy in which domestic demand is already weakening," he said.

Xu Hongyuan said an interest rate cut will boost investor confidence, which has been shaken by the slump in GDP growth.

"The government should keep cutting rates to show its resolution for supporting economic growth as long as economic indicators drop," he said.

Huang Yiping said such a cut could also help improve banks' asset quality by improving the corporate sector's profitability and ability to repay bank loans.

"This is because the sector's earnings are already being squeezed but real interest rates are rising," he said.

If the Chinese Government does not adjust interest rates, the corporate sector's financial conditions will probably deteriorate further, which may lead to a further build-up of non-performing loans in the banking sector.

"If the interest rate is cut by 50 base points, we estimate the corporate sector's interest burden could be reduced by 55 billion yuan (US$6.6 billion) in one year." Total outstanding loans were 10.9 trillion yuan (US$1.3 trillion) in 2001.

Experts also noted that a rate cut should not add significant pressure on the exchange rate given China's healthy external accounts and strong foreign reserve position.

However, both Xu Hongyuan and Xu Lianzhong said the best time for a rate cut would have been last October, when deflation reared its nose and the rate of GDP decline picked up.

"Having missed the best opportunity, GDP performance in the later half of this year will still be very bad even if the cut is implemented before the middle of February, as monetary policy usually takes a period of time to take effect," Xu Hongyuan said.