The interest rate cut by the Chinese government is an important development on the path to changing its economic model, while reducing an ‘Armageddon’ scenario, economists have said.
The People’s Bank of China surprised some market participants by cutting its benchmark lending rate by 40 basis points (bps) to 5.6 per cent and lowered its deposit rate by 25bps to 2.75 per cent earlier this month.
The move came after the country had posted its slowest growth in five years in the third quarter, while fixed asset investment also hit a 13-year low last month.
Equity markets responded positively to the move, but strategists and economists have said the rate cut is part of China’s move to a consumption-led economy and should help cushion it from major booms and busts.
Jan Dehn, head of research at Ashmore, said the timing of the move “surprised the market” but the central bank’s actions were “consistent with the general direction of travel in China”.
“China’s government is proactively re-engineering a transition of the economy towards consumption-led growth from export- and investment-led growth,” Mr Dehn said.
“This process is slowing the overall economy and putting downward pressure on inflation.
“The new growth model also requires new policy levers to manage the economy, particularly a greater reliance on interest rates.”
Mr Dehn added that the bank’s latest policy moves achieved two things.
“First, they help the economy through its economic transition,” he said.
“Second, they advance the objective of interest rate liberalisation. The latter is ultimately far more important than the former, in our view.
“The Chinese bond market is destined to be the main transmission mechanism for People’s Bank of China rate changes, and interest rate management is, in turn, going to be China’s principal instrument of macroeconomic policy in the future, just as it is in most developed economies.”
Neil Williams, group chief economist at Hermes Investment Management, said the rate cut was a “significant sea change in policy”.
“The authorities have spent the past six months ‘throwing the kitchen sink’ at the economy by easing policy by all means bar one – interest rate cuts,” he said.
“These were to be avoided to prevent stoking up the property and shadow-banking sectors.
“Today’s move – the first cuts for two-and-a-half years – suggests even China now considers demand inflation to be ‘yesterday’s problem’, but also raises the chance of shielding its official growth target.”
Abbas Owainati, chief economist at Old Mutual Global Investors, said he expected another 25bp cut in the second quarter next year and another one potentially in the subsequent quarter.
He also anticipates a 100bp cut in the reserve requirement ratios in the first half of 2015.
This is a measure of the amount of cash commercial banks have to hold in the central bank. The higher the level, the less banks have to lend to businesses and individuals.
Mr Owainati thinks that this will lead to economic growth of about 7 per cent for the next year.
The economist added that with this level of expected growth and inflation at roughly 1.6 per cent, this made China an attractive emerging market investment compared with its peers.
“Inflation remains a problem for a lot of emerging market countries,” he said.
“Investing in emerging markets needs to be done on a case-by-case basis and China doesn’t have the same problems as some of the others.”
However, not all areas of China will be a good opportunity. Companies exposed to construction and property will continue to struggle for the foreseeable future, according to the economists.
Meanwhile, other sectors, such as environmental clean-up and healthcare, will benefit from government reforms.
Cesar Perez, chief investment strategist for Europe, Middle East and Africa at JPMorgan Private Bank, said: “As the Chinese government is opening up the reform of state-owned enterprises through progressive liberalisation, investors will be able to start analysing the balance sheets of those companies to find which ones offer shareholder value and have the potential for improving return on equity.”
Financials should also be considered on a case-by-case basis, according to the economists.
