China rate cut: Zero should be the new normal

October 26, 2015 3:41 PM (UTC+8)

 

Sometimes enough isn’t enough.

China cut its benchmark one-year lending rate on Friday by 25 bps to 4.35% and also cut banks’ RRR by 50 bps for an estimated addition in liquidity of RMB 675 billion. It was the sixth cut in interest rates since November.

Asia Unhedged cheered the Chinese move which helped to lift markets along with the ECB’s threat/promise to lower rates and embark on QE2. But in the end, it came nowhere near the decisive monetary action needed to put China’s economy back on track and restore profitability to credit-starved Chinese companies.

Zero22A decisive rate cut to ZERO or just above in our view would signal government intention to restore the economy to overall health and, in particular, to come to the aid of credit starved small and medium enterprises. These are the firms that generate growth and employment. This is what’s needed to stabilize Chinese equities and induce sustainable stock market growth.

Is such drastic easing just a pipe dream or a realistic possibility? It is very realistic judging by the dynamics of the Chinese economy and the longer-term economic policies to be debated by the CCP central committee during its Oct. 26 – 29 plenary.

There is consensus at the top levels, most notably among President Xi and his minions, that reforms must accelerate if China is to meet its long-term development goals. But financial and serious enterprise reforms are of necessity deflationary and equivalent to monetary tightening. Support must come from decisively lower interest rates. That’s the logic of the reform process. Along with lower rates, it is equally necessary for China’s central bank to be prepared to allow greater RMB exchange rate flexibility, which must include a significant lowering of the value of the currency to restore an export competitive real effective exchange rate (REER).

 

 

 

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