Tag Archives: State Council

China’s Interest-Rate Liberalization Takes A Sideways Step

IS THE PAST prologue when it comes to China’s interest rates? For two years, the answer was no. Late last week, that answer changed with the central bank’s surprise cut in its benchmark one-year lending rate by 40 basis points (bps) to 5.6% and the matching deposit rate by 25 bps to 2.75%, its first cuts since July 2012. More to come is the question now.

An across-the-board measure is at odds with the targeted approach to managing the economy’s slowdown hitherto pursued by the People’s Bank of China. In September, it had injected 500 billion yuan ($81 billion) of liquidity into the five big banks to support credit and growth. Earlier in the year, it had cut reserve requirements for rural commercial banks and credit cooperatives.

Nonetheless, the central bank says that its rate move does not represent a change in monetary policy. In as much as the benchmark lending rate is largely symbolic, that may be true in a perverse way. The bank also lifted the maximum permitted deposit rate to 1.2 times the benchmark from 1.1 times. That is another incremental step in the direction of interest-rate liberalization. However, it will also largely negate the effect of the newly announced rate cut on the economy.

If anything the asymmetric cut will amplify the narrowing of the gap between lending and borrowing rates that has been going on for some time. That, we think, is more likely to cool the home-building market, as it will make home-buying loans even less profitable for banks than they are now, than to stimulate it.

If the economic mood music does not seem to presage further cuts, this Bystander suspects that factional infighting is underway, with the State Council leaning on the central bank to cut corporate borrowing costs. That mostly benefits the politically well connected large state-owned enterprises, who do not particularly need to borrow money, but will be happy enough to see their profit margins expanded through lower financing costs. As we have noted before, there are still vested interests providing considerable obstacles to the drive for economic reform.

The language of the central bank’s explanation of its rate move is telling. It is casting the cut in terms of financing costs, especially for small businesses, rather than a need to stimulate a slowing economy. However, if it is serious in what it says about guiding market rates lower, it would be best served by advancing the cause of interest-rate liberalization.

In its statement explaining the cut, it says:

Market-oriented interest rate reform is a systematic task, and calls for coordination with other reforms. Therefore we need to strengthen the coordination of various reform measures, unite those together as a force, and in the end finish building the mechanism and system to fully allow for the market’s decisive role in resource allocation and better allow the government to function.

The central bank has been a leading proponent of financial reform. Those measured words sound like it is on the back foot at the moment in the broader political debate.

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Lightening Up China’s Heavy Industry

Having failed to cut the overcapacity in China’s heavy industries from the top down, Beijing is going to try to do it from the bottom up. The State Council — China’s cabinet — has approved a plan  to give more power to market-forces to reshape smokestack industries such as steel and cement making, shipbuilding, aluminum smelting and sheet glassmaking.

All have been plagued by a glut of overcapacity that has debilitated profits and left firms in those sectors dependent on government subsidies to cover their losses. A quarter to a third of capacity in the aluminum and steel industries is unused, for example. The big state-owned enterprises had been charged with consolidating those and other heavy industries. In the event it was just the bloat that got consolidated. Earlier this year the industry ministry put more than 1,400 companies in 19 industries on a hit list of those instructed to cut capacity.

Apart from encouraging the private sector to apply the profit motive, the State Council also approved environmental and quality standards as a way of eliminating smaller, inefficient and outdated plant (a stratagem used with some success in the coal, brick making and rare earth industries), tax incentives for companies to move production offshore, and a ban on new project approvals within China. It is also hoping more growth and domestic demand will absorb more of what capacity is left after all that.

One thing central government does need to do is stop growth-minded provincial and municipal officials with an eye on creating jobs and tax revenue at any cost from providing incentives to companies to set up shop locally regardless of the viability of projects. Industry and IT vice-minister Su Bo said last month that “administrative interference” in industry was one of the biggest causes of overcapacity. Su particularly pointed to the market distortions caused by preferential land allocation, an administrative measure directly in the gift of local officials.

China has another urgent need to modernize its heavy industry. Much of it is still in the middle and lower reaches of the global value chain. Yet its cost competitiveness is increasingly eroded by lower wage economies elsewhere in Asia. What is increasingly been referred to as “technology- and talent-intensive” manufacturing is what China needs. An injection of that into heavy industry is more like to come from entrepreneurial private companies than the old state-owned heavyweights. “Core technology and enterprise management must make breakthroughs to deliver growth through innovation,” said the State Council in a sentence that could have come straight out of any American business school.

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