Will the Central Bank Continue to Cut Interest Rates?

Facing severe financial crisis, the US, Japan and Europe have adopted a series of measures to lower interest rates, even adjusting them close to zero percent. Continuous efforts made by the People's Bank of China, China's central bank, to cut interest rates are causing people to wonder if China will implement a zero interest rate policy.

However, Zhou Xiaochuan, the Governor of the People's Bank of China, said during a media interview recently that under a loose monetary policy, the central bank will adopt different monetary control measures according to specific economic conditions instead of relying on the single monetary policy of adjusting interest rates. In addition, Yi Gang, Deputy Governor of the People's Bank of China, also said publicly that considering China's actual conditions, neither a zero interest rate nor quasi-zero interest rate policies are optimal choices. China's current interest rate is maintained at an appropriate level that is equally valuable as a stepping-stone for offense or a strong point for defense.

Financial liquidity to some extent improved

Impacted by the global financial crisis, the central bank cut the interest rate five times successively last year to unprecedented levels.

Experts say following the active fiscal policy adopted previously, which brought about an investment of four trillion yuan, these interest rate cuts concretely embodied countercyclical adjustments to monetary policy. These notable efforts to cut interest rates carried out a moderately loose monetary policy, which reflected the ability of monetary authorities to adopt a flexible and precise policy to expand the money supply according to China's actual economic conditions. More specifically, successive interest rate cuts were aimed at ensuring the sufficient supply of liquidity in the banking system and improving stable growth of currency credit, with the core goal of maintaining the growth rate.

However, January reports from the central bank show that the monetary supply in January increased 18.79 percent, renminbi loans grew 21.33 percent, and capital liquidity had improved.

Lian Ping, Chief Economist of the Bank of Communications, believes that due to factors such as the remarkable effects of the stimulus plan and the rapid growth in loans, "there is little room for a further interest rate cut."

Lian believes that there is no significant difference between the current deposit and lending rates in the domestic market and the actual rates in the US market. Further lowering interest rates may cause capital outflow, the last thing monetary authorities in China want to see.

In addition, the central bank will take the profitability of banks into account, because the continuous lowering of interest rates has already immensely affected bank profits. Given factors such as interest rate cuts and the economic downturn, he predicts that overall bank profits will drop to 5 to 10 percent in 2009. Further lowering interest rates will put more pressure on bank profits.

Confidence in coping with deflation is firm

Zhang Jianhua, Director of the central bank's research bureau, recently said publicly that the interest rate cannot be cut to a range near zero. He pointed out that even though eased inflation pressures have left room for the central bank to further cut the interest rate, the Chinese economy has not reached that extent of deflation. Thus, the central bank currently has no sense of urgency to continue cutting interest rates, let alone follow China's major trading partners, the US and Japan, in lowering the interest rate to the range near zero.

If the interest rate falls into the range near zero, there will be no way for monetary policy to operate. Monetary policy may even enter a "liquidity trap." If the increased liquidity fails to enter the real economy, problems will still exist.

Yi Gang, Deputy Governor of the People's Bank of China, noted that it is not a good option for China to adopt a zero interest rate policy or a quasi-zero interest rate policy.

Reasons lie in that: Chinese savings deposit balances as a proportion of China's GDP is high; both Chinese labor productivity and factor productivity have been constantly improving; the rate of return on capital does not support a zero interest rate policy; and too low interest rates will not sustain commercial banks. He added that the central bank's determination to cope with deflation and keep the currency stable is firm. It is completely possible to effectively adopt a moderately loose monetary policy by means of an optimal combination of various monetary policy tools.

Arguments that China's interest rate is too high are incorrect

Responding to recent arguments that China's interest rate is too high, Yi said, compared with Japan's and the US' quasi-zero interest rate policies, China's interest rate level seems quite high, with the benchmark lending rate at 5.31 percent and the benchmark deposit rate at 2.25 percent.

However, each nation's central bank adopts completely different interest rate calculation standards so they cannot be compared merely by numbers. China's interest rate level actually is not high.

For instance, China's one-year renminbi lending rate is now 5.31 percent and its one-year renminbi deposit rate is 2.25 percent. The US' deposit rate is around 2 percent and its residential mortgage rate is around 5.33 percent. China's residential mortgage rate is now slightly lower than the US'. Yi also gave further explanations regarding what he previously said about there not being much room for a further rate decline in China. He said that does not mean China will not slash rates anymore. China's interest rate level must be kept at a position where it can take offense and defense, rather than not moving anymore.

The 2009 China's Macro Economy and Financial Situation Outlook released by the Bank of Communications on February 22 shows that following successive interest rate cuts recently, China is expected to reduce the rate one more time this year by 27 basis points.

By People's Daily Online