China Cuts Interest Rates To Record Low As Stock Market On Cusp Of Bear Market

China’s Central Bank has cut interest rates to a record low and has lowered the reserve-requirement ratios (RRR) for some lenders as Beijing seeks to revive the country’s sluggish economy which is poised for the slowest economic growth in twenty-five years.

The interest rate cut by China’s Central Bank, the People’s Bank of China (PBOC), is the fourth cut since November and is the first time the Central Bank simultaneously cut interest rates and reserve requirements since the height of the global financial crisis in late 2008.

The one-year lending rate was cut by 25 basis points to 4.85 percent starting June 28, one-year deposit rate was cut by 25 basis points to 2 percent, and reserve ratios for some lenders including city commercial and rural commercial banks was cut by 50 basis points, according to a statement on the Central Bank’s website.

The reserve requirement for finance companies was cut by 300 basis points, which it said will help ease funding and costs pressure on state-owned enterprises (SOE), a move which highlights rising concern over the SOE sector where bad debt is concentrated and profit margins are being squeezed.

The PBOC said that the RRR reduction was aimed at boosting financial institutes’ abilities to support farmers, rural and agricultural development as well as small and micro businesses.

In April, China last cut its reserve requirement ratio for all commercial banks by 100 basis points, which was the biggest single cut since the global financial crisis in 2008.

The combined easing efforts announced on Saturday highlights Beijing’s concerns that money isn’t flowing to some of the most-needed sectors in the economy and that stubbornly high borrowing costs that could fuel bankruptcies and job losses, Reuters said.

The move by the PBOC follows the biggest two-week plunge in China’s stock market since December 1996.  On Friday, the Shanghai Composite Index plunged 7.4 percent, taking its decline from its June 12 high to 19 percent, right on the cusp of a bear market.

Since hitting a 52-week high on June 12, the market selloff in China has wiped out around $1.25 trillion in market capitalization, an amount roughly equal to the size of Mexico’s economy, according to the Wall Street Journal.

“A plunge at that pace could have forced margin calls and another round of selling, leading to a stampede,” Lu Ting, Chief Economist at Huatai Securities told Bloomberg. “So avoiding panic in the financial market and protecting market confidence is part of the consideration.”

Many market participants attribute China’s stock market plunge due to the confusing signals sent by the PBOC.  Here is more from the Wall Street Journal:

Many market participants attribute the stock-market plunge to the confusing signals sent by China’s central bank. On the one hand, they say, the PBOC appears to be committed to further loosening credit; on the other hand, the central bank has quietly taken steps to drain liquidity from the banking system—moves that have led some in the market to suspect a change of stance in China’s monetary policy.

For the central bank, the confusion underscores a thorny issue it is struggling with after having delivered a barrage of big-bang easing steps since November: How to get Chinese banks to lend more to struggling companies while discouraging them from funneling funds to the country’s increasingly speculative stock market.

Nonetheless, the move by the PBOC is widely seen as an effort to restore investor confidence as the selloff threatens to derail China’s recent efforts to restore growth momentum.

Some say the PBOC move is reminiscent of a strategy pursued by former U.S. Federal Reserve Chairman Alan Greenspan, who cut rates following market meltdowns in what became known as the “Greenspan Put.”

“Similar to the Greenspan Put after Black Monday in 1987, this time it’s the PBOC’s turn to play ‘put’ after Black Friday,” said Larry Hu, head of China economics at Macquarie Securities in Hong Kong.

Although a speculative market, the Chinese government wants to keep its bull market intact. Here is more from the New York Times:

The two measures send a signal that the government may not be eager to see an abrupt end to a stock market rally that has seen prices more than double in the last 12 months. The rally has been underpinned by speculative trading heavily financed with borrowed money. Young, often poorly educated investors have been betting on further appreciation even as business managers, with more information on the true health of their companies, have reportedly been selling heavily.

“We think today’s move is mainly driven by the government desire to support a bull market,” Lan Shen and Shuang Ding, two economists at Standard Chartered, said in a statement on Saturday evening.

Keeping the stock market buoyant, through measures like the interest rate cut, could help the Chinese government sell part of its stakes in government-owned enterprises that have incurred huge debts.

Previous moves by the Chinese government, such as the interest rate cut on May 10, have also followed market selloffs.

“The simultaneous cuts in interest rates and reserve requirement is a forceful move, indicating the downward pressure on the economy is very big,” Xu Hongcai, senior economist at the China Centre for International Economic Exchanges (CCIEE), a Beijing-based think-tank, told Reuters. “The monetary policy adjustment will also help curb sharp fluctuations in the stock market.”

The Chinese government has doubled the size of its debt swap program, which alleviates a funding crunch for local governments and offers cheaper financing.  Local governments are set to issue around 2.8 trillion yuan ($451 billion) of debt this year, which will add a further strain on liquidity.

On Wednesday, in one of its boldest steps in banking reform, China’s cabinet, the State Council, said it is moving to end a two-decade-old banking rule that has capped lending relative to deposits.

The move will reduce the country’s overall financing costs and bring it one step closer to full interest rate liberalization.

The new measure by China will help boost credit expansion as the nation looks to revive economic growth as Premier Li Keqiang seeks to usher in market-based economics.

The draft amendment to the banking law in China proposes the removal of the lending cap that has long barred banks from lending more than 75% of their deposits. The draft amendment will be submitted to the Standing Committee of the National People’s Congress, China’s parliament, for the final approval, the cabinet said.

Chinese Premier Li Keqiang is aiming to overhaul its state-run banking industry that has around $29 trillion of assets, nearly twice the amount of that in the U.S.. Deregulating the nation’s interest rates and easing regulatory controls are part of Li’s efforts in order to support long-term growth by thus giving markets a larger role in the economy.

According to Reuters, the removal of the debt-to-loan ratios (LDRs) would potentially allow 16 listed banks to release up to 6.6 trillion yuan ($1.1 trillion) in extra lending.

In April, we reported that the PBOC was injecting $62 billion of its foreign exchange reserves into two state-owned policy banks to support China’s “One belt, One road” initiative, known as the New Silk Road project, which is aimed at creating infrastructure in order to boost connectivity and trade between Asia, Europe, the Middle East, and Africa.

As part of the New Silk Road project, we reported that China will invest close to $900 billion into more than 900 projects in 60 countries.

In May, we reported that China’s economic planner, the National Development and Reform Commission (NDRC), said it was seeking private funding for over 1.97 trillion yuan ($317.75 billion) for 1,043 public-private partnership (PPP) projects.

In April, we reported that China was planning to cut the number of its central government-owned enterprises to 40 through massive mergers and acquisitions as part of a sweeping plan to overhaul the country’s underperforming state sector.

China’s central government currently owns 112 conglomerates, including 277 public firms which are listed on the Shanghai or Shenzhen stock exchanges with a market capitalization of over 10 trillion yuan ($1.61 trillion).

China’s economic growth in the first quarter (Q1) of 2015 reached the slowest quarterly pace in six years at 7 percent from a year earlier, as it was dragged down by a combination of an industrial slowdown, a weak housing market, and local debt.

The Chinese government is slated to release second-quarter gross domestic product (GDP) data on July 15 as many economists anticipate that growth will slip below 7 percent.

In March, China lowered its economic growth forecast to “about 7 percent” in 2015 as the nation adjusts to a “new normal” of slower but more sustainable growth.

A full-year growth rate of 7 percent would be its slowest annual rate of expansion in 25 years.