Schroders Quickview: Chinese stimulus to boost sentiment, but not growth yet

  • PBoC cuts interest rates by 25 basis points
  • Reserve requirement ratio cut by 50 basis points
  • Cuts are a positive for liquidity and lending
  • China resurgence not on the cards

Liquidity restored

The cuts follow a disastrous few days on the equity markets, but we do not believe the PBoC wishes to reflate that particular bubble.

However, the magnitude of the slump in the stockmarket is likely to have a negative impact on sentiment, especially given a weak economic environment (we saw a much softer-than-expected manufacturing Purchasing Manager’s Index (PMI) print last week).

Stimulus measures should help market sentiment, but we do not expect a resurgent China as a result.

In addition, the change in exchange rate policy which resulted in a devaluation of the renminbi has seen capital outflows, which in turn have reduced liquidity and led to tighter monetary conditions.

By cutting the RRR, alongside recent market operations, this liquidity is restored and lending supported. Interest rate cuts, meanwhile, should reduce borrowing costs for existing borrowers, particularly households and state-owned enterprises.

Will this stimulus drive a growth rebound?

We are doubtful:

  • The RRR cut likely just restores lost liquidity.
  • The interest rate cut, while helpful, probably just forestalls defaults, rather than encouraging investment in an economy beset by deflation, overcapacity, and high debt levels.

Further, previous rate cuts have done little to lower borrowing costs for new borrowers, as bank interest margins have been squeezed by asymmetric effects on deposit rates compared to lending rates.

This asymmetry has eased thanks to further deposit rate liberalisation, but banks may still seek to restore some of their lost margins, particularly given their mandatory participation in the local government debt swap.1.

In short, the stimulus measures should help market sentiment, but we do not expect a resurgent China as a result.

1. Banks’ interest margins have suffered as a result of a programme implemented by the finance ministry that enables local governments to swap existing debts on which they are paying high interest rates for lower-cost bonds which banks are obliged to buy. While this is beneficial for local governments, the banks who lent them the money in the first place now have to accept coupon payments on the debt that are lower than the interest they could previously charge, which has affected interest income and margins.