Implications of China’s interest rate cut
by iFast Research Team. Posted on June 24, 2012, Sunday
Since the end of last year, the People’s Bank of China (BOC) has cut its reserve requirement ratio (RRR) three times, with the most recent cut effective just weeks ago.
Given that all the major economic indicators published in May disappointed markets, it is probably widely agreed upon that the recent interest rate cut was necessary to support China’s economy. Although an interest rate cut will likely be more effective than the previous RRR cuts, we nonetheless view the cut as ‘good, but not good enough’.
What’s ahead for the economy?
A surprise interest rate cut is not all good news. Given that inflationary risks had not vanished, the rate cut was evidently implemented in order to ease mounting economic stress. It is also a sign that the economic conditions were worse than expected.
The timing of the interest rate cut was also interesting as it was done just a couple of days before a range of critical data releases for May, including industrial production and trade figures for the weekend and new loans for the following week.
Once again, we witnessed the BOC’s policy fine-tuning in action as it implemented more drastic measures in order to preemptively offset the upcoming weak data releases.
Recent publications of weak economic data had demonstrated high levels of uncertainty surrounding China’s economic outlook in the short term. This one-time rate cut was not going to ensure a rebound in these economic indicators for the following months but it did remind us that the central bank still had room to manoeuvre and was equipped with a range of policy tools to utilise in face of potentially deteriorating conditions.
Therefore, we do expect further policy moves to come, which will involve both RRR-cuts and further interest rate cuts. At the same time, the timing of these policies will be difficult to predict and highly dependent and sensitive to the upcoming economic trends.
It is also worth noting that, although it appears as though the government has shifted its focus away from inflation towards growth considerations, we believe the headline CPI figure will still continue to be a determinant factor for monetary policy.
Chances for another four trillion yuan stimulus
Not a chance. Though faced with another period of weak economic growth with stock markets plummeting and resembling that of 2008’s, China’s economy faces different challenges today, making a fiscal stimulus package, with the size of four trillion yuan, highly infeasible.
Faced with the financial crisis, the central government implemented a fiscal stimulus package three and a half years ago, the size of approximately 10 per cent of gross domestic product (GDP). The stimulus helped the nation avert a marked economic slowdown but the negative consequences proved to be large and to this date still present.
The lending spree by banks and overinvestments by local governments left the former with piling non-performing loans and the latter with piles of debt. Another major consequence was soaring property prices the government was still on a mission to control.
Given that the toxic consequences still persisting, we do not see any possibility for the government to make such bold moves again.
What investors should do
China’s economic situation has turned out to be worse than expected and the economy might only bottom out closer to the end of the year. However, in line with our expectations, the BOC continues to react sensitively to the apparent economic trends and ‘fine-tune’ policy.
The surprise rate cut is evidence of the central bank’s commitment to defend economic growth and thus our positive outlook for Chinese equities continues to be supported.
Despite a weak economic environment, investors should closely look at the fundamentals in the long run. After the sell-off in May, we have seen valuations dip to extremely attractive levels once again, declining to below the levels seen at the worst of the financial crisis in 2008. Hence we continue to favour the Chinese equity markets and maintain a five star or ‘very attractive’ rating on the market.
This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. Opinions expressed herein are subject to change without notice.