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

The People’s Bank of China (PBoC) moved to cut both the benchmark interest rate and reserve requirement ratio (RRR) today. The stimulus measures should help market sentiment, but we do not expect a resurgent China as a result.

25 August 2015

Craig Botham

Craig Botham

Emerging Markets Economist

  • 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.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.