Rate Cuts Highlight Tricky Growth Balance China Has To Strike

Chart showing China's quarterly GDP growth year-on-year from Q1 2019 to Q4 2021

CHINA HAS CUT interest rates for the first time in two years as the property sector debt crisis and a resurgence of Covid-19 weigh on the economy.

Fourth-quarter GDP growth came in at 4.0% year-on-year, its slowest pace of growth in 18 months. Quarter-on-quarter growth was 1.6%, up from the third quarter’s 0.7% but still far from robust.

While both the y-o-y and q-o-q numbers slightly exceeded consensus expectations, they confirm the return to the trend slowdown in growth seen before the distortions of the pandemic.

Year-on-year growth slowed in each quarter last year, although the economy expanded by 8.1% for the full year as it bounced back from 2020’s initial outbreak of Covid-19. The official target for 2021 was ‘over 6%’.

Retail sales rose by only 1.7% in December, much less than forecast, as new Covid-19 outbreaks forced new lockdowns in several cities. Investment also slowed, although industrial output rose.

The interest rate cuts by the People’s Bank of China signals a more assertive monetary approach than the easing already seen in the third quarter with the lowering of banks’ reserve requirement ratios.

Today’s cut in the benchmark one-year loan prime rate by ten basis points to 2.85% and the rate on seven-day reverse repurchase agreements to 2.1% follows December’s five-basis-points cut in the one-year policy loans rate. The five-year loan prime rate, the benchmark rate for mortgages, was left unchanged, but a reduction in that sooner rather than later would not be a surprise.

The reverse repo rate cut is the more unexpected of the latest cuts. It reflects authorities intention to stabilise the economy well ahead of the Party congress later this year when President Xi Jinping will likely be anointed to a third term.

A managed slowing of growth to rebalance the economy is politically tolerable, providing it comes with no social disruption. However, a property sector collapse with widespread developer defaults and the financial and social risk that would bring would not be.

The debt overhang remains serious. Corporate debt was still 156.8% of GDP in the second quarter of 2021. That is down from 163.4% a year earlier but still high enough to complicate the way forward for policymakers aiming to stimulate growth while reducing the economy’s reliance on debt-fuelled infrastructure investment and export-oriented manufacturing.

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