The People’s Bank of China (PBOC) kicked off a new easing cycle on Monday by lowering interest rates for the first time in four years – a move designed to safeguard against further trade-war turbulence.
For all the talk about President Trump being “easy to read,” China doesn’t seem to be fairing too well in the now multi-year trade war. But the need to lower interest rates reflects a deeper problem that extends far beyond tariffs.
PBOC Cuts Interest Rates
On Monday, the Chinese central bank announced it plans to lower the seven-day reverse repo rate to 2.5% from 2.55%. While the move is tiny relative to what other central banks are doing, it’s the first reduction since 2015.
The central bank also conducted another open market operation, injecting some 180 billion yuan ($25.7 billion) into the monetary system.
The move wasn’t entirely unexpected. Just days prior to the rate cut, PBOC disclosed that “a divergence of inflation expectations” may alter the course of monetary policy. Earlier this month, policymakers lowered interest rates on their medium-term lending facility, which is used by financial institutions for longer-dated funding needs.
PBOC Is Addressing a Wider Issue
PBOC is just the latest central bank to join the rate-cutting frenzy. Like its peers in the U.S., Europe and Oceania, PBOC is sending a strong signal that it’s worried about the economy.
The rate cut confirms that Chinese policymakers are concerned about the trade war, which has undermined business investment and contributed to the worst economic slowdown in almost 30 years. China’s weakening position is reflected almost everywhere, including industrial production, new manufacturing orders, exports, retail sales and fixed-asset investment.
Unfortunately for policymakers in Beijing, lowering interest rates won’t reverse a sharp decline in foreign and domestic demand. It certainly won’t be enough to boost manufacturing, which according to some measures has already entered a deep recession.
At best, a rate reduction may offer temporary reprieve against a slowdown in consumer spending and the historic trough in fixed asset investment, but doing so exposes another major issue: Excessive debt.
China’s Debt Bubble
As the Financial Times reported back in August, China is currently mired in an ever-growing debt bubble whose implications extend far beyond mainland markets.
According to Arthur Budaghyan:
China, like any nation, faces constraints on frequent and large stimulus, and its vast and still rapidly expanding money supply will produce growing devaluation pressures on the renminbi.
China total debt exceeds 300% of GDP. To put it in dollar terms: China owes U.S.$40 trillion, or roughly 15% of global debt.
Despite the credit risks facing China, analysts are becoming more convinced that more stimulus is on the way. This was reported by the South China Morning Post as far back as December 2018. At the time, analysts polled by the publication said PBOC would remain on the sidelines for another year before deciding to slash interest rates.
But just as previous rounds of easing failed to spur a sustained recovery in the aforementioned indicators, the latest reduction won’t be enough to alter the macro picture. If that’s the case, the central bank may adopt more aggressive stimulus measures to offset a deeper slowdown in the economy.
The irony in all this is that China itself is making a wilful turn away from traditional smokestack industries in favor of services and consumption. This transition is a generational effort – to grow the middle class and put the Chinese consumer on par with their Western counterparts. How this grand narrative plays out remains to be seen. In the meantime, China’s pace of expansion is expected to test new 30-year lows on a regular basis.