Recently, the People’s Bank of China lowered interest rates twice within three days to inject liquidity into the market. However, the stock market did not respond as expected. Following the initial rate cut, the three major indexes of A-shares performed poorly, with the Shanghai Composite Index still unable to break through the 2,900-point mark as of July 26th. Economists believe that the limited rate cuts by the People’s Bank of China reflect its dilemma, while the stock market’s performance indicates disappointment in the outcomes of the Third Plenary Session and pessimism towards the Chinese economy. The current crisis in the Chinese economy requires more than just minor adjustments like interest rate cuts to address.
On July 25th, the People’s Bank of China conducted a 200 billion yuan (approximately 27.6 billion US dollars) Medium-term Lending Facility (MLF) operation with a winning bid rate of 2.30%, down by 20 basis points compared to the previous rate. MLF is a monetary policy tool used by the central bank to provide medium-term liquidity to eligible commercial banks and policy banks through collateralized lending. The funds are typically available for three months to a year and are aimed at meeting the funding needs of agriculture, rural areas, and small and micro-enterprises.
On July 22nd, the People’s Bank of China announced a reduction in several benchmark lending rates. The 1-year Loan Prime Rate (LPR) was lowered to 3.35%, while the LPR for terms over 5 years dropped to 3.85%, both by 10 basis points, marking the second interest rate cut by the central bank this year.
The central bank stated that the rate cuts are intended to reduce financing costs for businesses and residents to stimulate consumption and investment. Additionally, the central bank adjusted the 7-day reverse repo operations to a fixed rate and quantity bidding, lowering the rate by 10 basis points to 1.7%.
The consecutive actions by the People’s Bank of China have raised questions about their objectives. According to official media reports, the central bank aims to shift its policy rate “anchor” from the previous MLF rate to the current 7-day reverse repo rate OMO, diminishing the policy rate color of MLF, and enhancing the policy tool positioning of the 7-day reverse repo rate.
Market analysts point out that the central bank’s frequent monetary policy actions are primarily driven by the persistently weak demand in the real economy, particularly in the lackluster real estate market, necessitating a reduction in financing costs to boost domestic consumption. Moreover, the expected interest rate cut by the Federal Reserve in September provides room for further monetary easing by the People’s Bank of China.
However, the market has not responded positively to the central bank’s measures. On the day of the first rate cut, all three major indexes in the Chinese A-share market recorded declines. The Shanghai Composite Index closed down by 0.61% at 2,964.22 points, the Shenzhen Component Index fell by 0.38% to 8,869.82 points, and the ChiNext Index dropped by 0.09% to 1,723.91 points.
Subsequently, on the 24th, the A-share market continued to decline, with the Shanghai Composite Index barely holding above the 2,900 level at 2,901.95 points. The Shenzhen Component Index was down by 1.32% to 8,493.10 points, and the ChiNext Index fell by 1.23% to 1,650.91 points. The number of declining stocks exceeded 4,400.
Responding to the series of actions taken by the central bank and the market’s reactions, economist David Huang pointed out that the Chinese economy is facing significant gaps in various economic activities such as exports, domestic demand, and investments, prompting the central bank to release liquidity through rate cuts.
Data released by the National Bureau of Statistics of China on July 15th shows a continued decline in China’s GDP growth rate in the second quarter.
Furthermore, the fiscal revenue and expenditure report for the first half of 2024 released by the Ministry of Finance on July 22nd indicates a 2.8% decrease in general public budget revenue of the Chinese government. Key tax revenues, including value-added tax, corporate income tax, personal income tax, and tariffs saw declines, while consumption tax increased by 6.8%, representing one of the few areas of growth in taxation.
Huang emphasized that the profound issues in the Chinese economy cannot be addressed solely through minor interest rate cuts. He suggested that structural reforms are necessary, expanding access for private enterprises, and implementing more encouraging policies for foreign investment. However, the recent Third Plenary Session did not provide any relevant information in this regard, leading to disappointment in the market’s expectations. The significant gap between the extremely low interest rate policy and market expectations has resulted in a lack of market confidence, reflected in the continuous stock market decline below the 2,900 level.
Typically, the interest rate decisions of the Federal Reserve serve as a reference for central banks worldwide. The People’s Bank of China’s preemptive rate cut before the Federal Reserve has garnered attention from the international community.
Economist Chengqing Li from the American Institute for Strategic Studies pointed out that previously, the People’s Bank closely monitored the interest rate movements of the Federal Reserve to determine the timing of rate cuts. Now, with the possibility of a rate cut by the Federal Reserve looming, the People’s Bank of China took swift action. The challenging economic issues faced by China, including the collapse of the real estate sector, risks in the banking system, local government debt issues, rising unemployment rates, and slowing exports, necessitated urgent interest rate cuts to stimulate the economy.
Li also mentioned that the meager 0.1% rate cut by the People’s Bank of China underscores its dilemma in striking a balance. In the United States, a change of 0.27% or more in interest rates is deemed significant in driving loan applications for housing or expanding investments. With the central bank of China only cutting rates by 0.1%, the market sentiments remain pessimistic, leading to consecutive stock market declines. The ability to maintain the 2,900-point threshold has become a pressing concern for the authorities.
Li highlighted that the central bank’s reluctance to implement substantial rate cuts stems from concerns about the Federal Reserve’s lack of formal rate cuts. A widening interest rate differential between China and the United States could accelerate capital outflows from China while increasing pressure on the depreciation of the renminbi, placing the People’s Bank in a difficult and delicate position between competing priorities.
In reality, the market signaled pessimism towards the Chinese economy after the initial rate cut. On the 24th, through the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, net capital outflows from Hong Kong into China amounted to 2.276 billion yuan (approximately 314 million US dollars). The total turnover reached 108.042 billion yuan (about 14.9 billion US dollars), accounting for 17.23% of the total transaction volume in A-shares.
Li echoed that the Chinese economy is in a downward spiral, and merely releasing liquidity through interest rate cuts will not reverse the trend. Genuine market mechanisms are required for resource allocation. Establishing a rule of law society and curbing centralized power are prerequisites for transitioning to a market economy. However, the current regime is moving in the opposite direction, reverting to a planned economy resembling the era of Mao Zedong.