The People’s Bank of China (PBoC), China’s central bank, has cut one of its key interest rates for the second time in three months as the country struggles to bounce back from the post-COVID economic crisis.
PBoC Cuts Interest Rates On Household And Business Loans To Get The Economy Moving Again
On Monday, the PBoC announced that it had trimmed its one-year loan prime rate, a benchmark commonly used for household and business loans, by 0.10 percentage points from 3.55% to 3.45%. While leaving its five-year loan prime, which is used to price mortgages, at the existing rate of 4.2%.
The central bank’s move surprised economists who had been expecting much stronger cuts for both lending rates. According to a poll conducted by Reuters, leading economists predicted a 0.15 percentage point reduction by the PBoC to support the struggling economy.
Just last week, the PBoC decreased the rate on its short and medium-term lending facility, the interest rate to banks, by 0.15%. This was done to lower bank borrowing costs throughout the country.
What is interesting is while other major economies like the U.S. are raising borrowing rates to tackle rising inflation, China has taken the opposite route that many thought would not happen considering the economic situation that the country is currently facing.
The world’s second-largest economy has slipped into deflation in the wake of the pandemic, resulting in a growth slowdown. Beijing is struggling to keep its head above the water as domestic spending has reduced due to prices continuing to drop year-on-year.
China’s Housing Market Struggles As Developers Are Defaulting On Liabilities
The slowdown heavily impacted the Chinese property market which has been reeling in crisis. On Friday, Evergrande Group, the once largest property developer in the country, filed for protection under Chapter 15 of the U.S. bankruptcy code in a desperate effort to restructure its large debts while safeguarding its assets outside China.
In 2020, Beijing tightened scrutiny on the debt levels of the highly-leveraged real estate market by introducing the “three red lines” policy. The so-called red lines set limits on liabilities-to-asset ratios to ensure that companies held cash reserves equivalent to at least 100% of their short-term debts.
This caused Evergrande to fall into a liquidity crisis, as the economic slowdown exposed the company’s large liabilities. At the time, it was reported that the real-estate mogul had debt of more than $300 billion, which it defaulted on. Thus becoming a poster child for China’s woes.
About 40% of all Chinese home sales have since defaulted. Last month, Evergrande posted a combined loss of $81 billion for 2021 and 2022.
Last week, Country Garden, the chief rival of Evergrande and one of the few homebuilders that have managed to avoid a default missed out on two dollar bond payments. The company, which was once one of the largest property developers in the country by revenue, warned investors that it could see a combined loss of up to $7.6 billion for the first six months of the year.
Country Garden has been given a grace period until early September to clear its debt or face the same fate as its counterparts.
The news is threatening the future of housing projects in China for which many investors have already made payments.
George Magnus, an expert on the Chinese economy and associate professor at Oxford University’s China Centre, said the instability in the property market – which accounts for a quarter of the country’s economy – could destabilize China’s finances and cause socioeconomic problems if developers fail to deliver pre-sold homes.
Speaking to BBC Radio 4, he said the market was propped up by the government for the better part of the last 2 decades, and every time the economy weakened, the banks offered loans to finance real estate construction and infrastructure under the impression that things were well-managed. Magnus pointed out that the “insulation” of the property market from restructuring has only started “coming home to roost”.
Post-covid Deflation Is Threatening To Derail The World’s Second-largest Economy
China has slipped into deflation for the first time since the 2020 lockdowns. Although the consumer price index, a measure of inflation, dropped by 0.3% in July, official figures show the country’s imports and exports fell sharply last month due to weakening global and domestic demand.
Unemployment rates are at their highest, as more than 20% of China’s 16-24-year-olds are struggling to find jobs. The situation is so bad that Beijing has stopped releasing youth unemployment numbers, which is seen as one of the key indicators of the country’s slowdown.
Economists expect the central bank to cut interest rates even further in a targeted attempt to help the housing market. Catherine Young, investment director at Fidelity International said the rate cuts could be announced in conjunction with government spending.
She also warned that while the government is trying to restore confidence in the economy, its policies will have long-term implications for the country.
Meanwhile, Julian Evans-Pritchard and Zichun Huang – economists for consulting firm Capital Economics – wrote in a report that the PBoC’s approach to monetary policy was of “limited use” in the current market environment and won’t be enough to revive demand as it would take much larger rate cuts and other regulatory measures to “effectively restore confidence in the housing market”.