China’s central bank expected to gradually and moderately cut interest rates and

China’s central bank expected to gradually and moderately cut interest rates and required reserve ratios in 2009

Source: December 23, 2008  16:05

[Shihua Financial Information] Since China’s interest rates have been drastically lowered, quantity tools might be used more frequently than price tools in the future. Required deposit reserve ratios are likely to go down at high frequency. In 2009, priority will be given to gradually and moderately cut down interest rates and required deposit reserve ratios.

According to foreign media reports on December 23, Chinese central bank was expected to continue ease its monetary policy at the end of the year, with mild moves. The central bank was estimated to give priority to gradually and moderately reduce interest rates and lower required deposit reserve ratio in the next year. Since China’s interest rates were already fairly low as a result of rounds of interest rate cuts, future quantity tools are expected to be more frequently used than price tools, and required deposit reserve ratios are likely to be reduced more often.

On the evening of December 22, the central bank announced to slash the one-year RMB benchmark interest rates for savings deposits and loans by 27 percentage points respectively on December 23, and reduce the RMB required deposit reserve ratio of financial institutions by 0.5 percentage points on December 25. It was the fifth time in the second half of 2008 that the central bank lowered the loan interest rates, and the fourth time to reduce the deposit interest rates and required reserve ratios. By that time, the one-year benchmark deposit interest rate was reduced to 2.25%, the lowest since June 1999.

Since the Fed of the United States drastically reduced the interest rate to record low last week, and leading Chinese domestic economic indexes 走软, this round of interest cut by the Chinese central bank was widely expected.

Since economic downturn and deflation are in greater risks in the first half of 2009, industry officials generally believe China will continue with the easy monetary policy, Chinese central bank will go on reducing interest rates and required deposit reserve ratios will continue to drop in 2009. However, the central bank might rely more heavily on quantity tools in its controls in 2009. Interest rates will be less frequently and dramatically lowered in 2009 than in the previous year. Required deposit reserve ratios are likely to assume greater roles, projecting vast downward potentials.

In 2009, price indexes will inevitably drop by big margins. It has become a general trend to go on cutting interest rates. Shenyin & Wanguo Securities estimates the growth rates of China’s producer price index (PPI) will reduce from this year’s 7% to -7% in 2009, while the growth rate of consumer price index (CPI) will drop from this year’s 5.9% to -0.2%. Along with gradual drop of price indexes, the central bank will surely go on to lower interest rates to drive the economy out of the mud.

Although China has dramatically cut down interest rates by a total of 189 base points this year, the current round of interest rate adjustment has not yet reached the lowest point. The central bank is likely to reduce the one-year time deposit interest rate down to under 2% in 2009, a record low since 2002. A most popular view of the market holds China’s central bank might pull down the one-year interest rates for savings deposits and loans by about 81 base point in 2009.

However, it must be noted China’s central bank takes fairly moderate step in the present interest rate cut since the Federal Fund rate was lowered near zero. It was weaker than the previous market expectation of 54 base points cut, projecting a policy signal the central bank might wait for opportunities to gradually and moderately cut down interest rates. China might reduce interest rates at obviously slower paces in 2009. Considering the forward looking nature of interest rate policies, China will largely face interest reduction pressure in the first half of 2009 when the economy might decline heavily.

In order to prevent the growth rate of M2 from continuing to drop, keep enough liquidity in the financial system, and facilitate the economy to recover rapidly, the quantity policy tool of required deposit reserve ratio might be lowered more frequently in 2009.

According to the Opinions of General Office of State Council on Promoting Economic Development with Financial Support, recently promulgated on the official web portal of the Chinese central government, China will ensure sufficient liquidity in the banking sector and promote steady growth of currency credit. The State Council has announced China will keep annual M2 growth at about 17% in 2009, higher than the existing 14.8% level. It implies the central bank must go on increasing basic money supply.

As shown in the latest report of Guotai Junan Securities, China might reduce required deposit reserve ratio by an average 0.5 percentage points each month. The required deposit reserve ratios will fall to under 10% by the end of 2009.

(Edited by Yuan Jiafeng)

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