China has lowered one of its main benchmark lending rates for the second time this year, in a bid to boost economic recovery in the world’s second largest economy. The move comes amid growing concerns over the impact of the Covid-19 pandemic and the ongoing trade tensions with the United States.
What is the loan prime rate?
The loan prime rate (LPR) is the interest rate that commercial banks charge their most creditworthy customers. It is based on the rate that the People’s Bank of China (PBOC), the country’s central bank, lends to banks through its medium-term lending facility (MLF).
The LPR is a key indicator of the cost of borrowing for businesses and households in China. It also influences other interest rates in the economy, such as mortgage rates and corporate bond yields.
The PBOC sets the LPR every month, based on the average rate that 18 selected banks submit. The LPR has two maturities: one-year and five-year. The one-year LPR is more closely linked to the MLF rate, while the five-year LPR reflects the long-term funding conditions in the market.
How much did China cut the LPR?
On Monday, August 21, 2023, the PBOC announced that it had cut the one-year LPR by 10 basis points from 3.55% to 3.45%. This is the second time this year that China has lowered the one-year LPR, after a 15 basis point cut in February.
The PBOC did not change the five-year LPR, which stands at 4.20%. The five-year LPR is more relevant for the housing market, as it is used as a reference for mortgage loans.
The PBOC also injected 100 billion yuan ($15.4 billion) into the banking system through the MLF on Monday, at an unchanged rate of 2.95%. The MLF is a tool that the PBOC uses to provide medium-term liquidity to banks and guide their lending behavior.
Why did China cut the LPR?
China’s decision to cut the LPR reflects its efforts to support economic growth amid multiple headwinds. The Covid-19 pandemic has caused disruptions to production and consumption, especially in regions hit by outbreaks of the Delta variant. The trade tensions with the US have also weighed on China’s exports and business confidence.
China’s economy grew by 7.9% year-on-year in the second quarter of 2023, slowing down from a record 18.3% growth in the first quarter. The slowdown was partly due to a high base of comparison, as China’s economy contracted by 6.8% in the first quarter of 2020 due to the pandemic.
However, some analysts have also pointed out that China’s growth momentum has weakened in recent months, as shown by indicators such as industrial output, retail sales, fixed asset investment, and credit growth.
By lowering the LPR, China aims to reduce the financing costs for businesses and households, and encourage more borrowing and spending. This could help stimulate domestic demand and offset some of the external pressures.
What are the implications of China’s LPR cut?
China’s LPR cut could have positive effects on both its domestic and global economy. For its domestic economy, it could boost sectors such as manufacturing, infrastructure, and services, which rely heavily on bank loans. It could also support consumer spending, especially on big-ticket items such as cars and appliances.
For its global economy, it could increase China’s imports of goods and services from other countries, especially those that are part of its Belt and Road Initiative (BRI). It could also ease some of the deflationary pressures that China has been exporting to other countries through its low-priced goods.
However, China’s LPR cut also comes with some risks and challenges. For one thing, it could add to China’s already high debt levels, which have risen sharply since the pandemic. According to the Institute of International Finance (IIF), China’s total debt reached 317% of its GDP in the first quarter of 2023, up from 300% in the same period last year.
For another thing, it could fuel asset bubbles in sectors such as real estate and stock markets, which have already seen rapid price increases in recent years. This could pose financial stability risks and social problems for China in the long run.
Moreover, it could complicate China’s monetary policy coordination with other major economies, especially the US. The US Federal Reserve has signaled that it may start tapering its bond-buying program later this year and raise its interest rates next year, as its economy recovers from the pandemic. This could create a divergence between China’s and US’s monetary policies, and lead to capital flows and exchange rate fluctuations.
How will China balance its policy goals?
China faces a delicate balancing act between supporting economic growth and maintaining financial stability. It has to weigh the benefits and costs of easing or tightening its monetary policy, as well as its fiscal policy and regulatory policy.
China has adopted a “prudent” monetary policy stance since 2017, which means that it tries to avoid excessive stimulus or contraction. It has also adopted a “proactive” fiscal policy stance, which means that it tries to increase government spending and reduce taxes.
However, China has also been tightening its regulatory policy in recent years, especially in areas such as fintech, antitrust, data security, and environmental protection. It has also been cracking down on shadow banking, local government debt, and property speculation.
These policies have been aimed at addressing some of the structural problems and imbalances in China’s economy, such as overcapacity, inequality, corruption, and pollution. They have also been aimed at enhancing China’s technological innovation and strategic autonomy.
However, these policies have also created some short-term pains and uncertainties for China’s economy, as they have affected the operations and profits of some of the leading companies and sectors in China. They have also triggered some market volatility and investor caution.
Therefore, China has to strike a balance between its short-term and long-term policy goals, and between its domestic and external policy objectives. It has to calibrate its policy mix and timing according to the changing economic conditions and challenges. It has to communicate its policy intentions and actions clearly and effectively to the public and the markets. And it has to coordinate its policy actions with other countries and international organizations to foster global cooperation and stability.