China rate cut targets financial not economic ills
By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
China’s surprise interest rate cut looks like a response to financial rather than economic ills. Thursday evening’s reduction in the lending rate by 31 basis points and the deposit rate by 25 points won’t alone do much to change the economic picture even if data due next week show activity is markedly slowing down. What it will do is buy banks and lenders some time, and postpone the more imminent danger of a rise in bad loans.
Lower rates can stimulate more borrowing, but they probably won’t in this case. Despite a cut in rates just a month ago, lending in China seems to have slowed dramatically in June. Some banks can’t lend because their deposit funding is too scarce; others can’t find clients who want to borrow. Many state-owned borrowers in sectors like steel and aluminium face overcapacity already. Bank loan approvals are easier to get than they have been for two years, a Nomura analysis shows, while loan demand is at its lowest since 2008.
In a country growing as fast as China, price shouldn’t be a motivating factor for most borrowers. Returns on capital in from 1993 to 2005 were 20 percent, according to a study for the National Bureau of Economic Research*. Even assuming that has moderated quite a bit, it makes little odds for many private companies whether the base rate for borrowing is 6 percent or 6.31 percent.
It’s overstretched borrowers that will feel the difference. With the real estate sector in deep-freeze, many developers will be struggling to service their borrowings. For them, a 31 basis point cut, which banks are theoretically able to turn into an 85 basis point lower rate, might make the difference between getting by and going bust. It may also coax some who have sought short-term funds from non-bank lenders – be they domestic Chinese private equity funds, trust companies or more shady sources – to go back to the banks.
That helps the banks too. While the bad debts they report are still only around 1 percent of all loans, current valuations suggest investors suspect the real figure is as much as 6 percent, according to Bernstein Research. Cutting rates doesn’t make bad borrowers good, but it does delay the day of reckoning. That reduces the chance that a financial crisis brings on an economic one.