More rate cuts expected, but timing unclear

Editor's Note: The central bank announced an asymmetric cut in benchmark interest rates on Nov 21－the first reduction since June 2012. The one-year lending rate fell 40 basis points to 5.6 percent and the one-year deposit rate went down 25 bps to 2.75 percent. The People's Bank of China also advanced its interest rate liberalization agenda by authorizing deposit rates that are 20 percent above the benchmark rate, up from the previous 10 percent. Observers are seeking clues as to when and how the central bank will further ease monetary policy, liberalize interest rates and accelerate financial reforms. Several economists and analysts provide their thoughts on these matters here.

Liu Linan, greater China rates strategist, Deutsche Bank AG

We believe that the central bank is committed to alleviating corporate funding difficulties and to tackling structural issues with accelerating interest rate reforms after the rate cuts on Nov 21.

The People's Bank of China is expected to establish a deposit insurance system before the end of this year. That will pave the way for the PBOC to abolish the policy deposit rate curve and policy lending rate curve, steps that we expect will occur in late 2015.

By that time, the prime rate curve will develop into a market-based curve, and the policy deposit rate curve will be replaced with a short-term policy rate target, which will be either the overnight rate or the seven-day rate. This rate would be the uncollateralized funding rate between financial institutions, similar to the Fed funds target rate, and it would most likely come from the Shanghai interbank offered rate market.

The PBOC could then actively engage in more frequent intraday open market operations to keep this short-dated SHIBOR rate close to its target.

The introduction of a short-term monetary policy rate could form the basis of a new monetary policy framework. It will significantly improve monetary policy transmission in the domestic financial market, which improves the efficient capital allocation in the aggregate economy.

Qu Hongbin, chief economist in China and co-head of Asian economic research, HSBC Holdings Plc

The rate cuts on Nov 21 point to a shift in the central bank's approach, as targeted quantitative easing was not as effective as it had hoped.

Weak data flows in recent months have prompted the government to take more decisive steps to stabilize growth. We now expect another 50 basis points cut to the policy rate and a 150 bps required reserve ratio cut in 2015.

The easing was intended to lower borrowing costs for the real economy and accelerate interest rate liberalization. More importantly, it reflected a change in policy approach from targeted to across-the-board easing. This is an important breakthrough and should open the door for further broad-based easing next year.

Chang Jian, economist in China, Barclays Capital

After the PBOC's rate cuts, we believe that banks will fully utilize the upward flexibility.

The market will likely read this as a positive signal that the government is responding to worsening private demand and rising deflation risks and is finally willing to send a strong signal to the market. We think the disappointing traffic in the first week of the Shanghai-Hong Kong Stock Connect may have been a driving factor.

We maintain our 7 percent GDP growth forecast for 2015. We look for two more symmetric cuts. After evaluating the effect of the PBOC's asymmetric move, we are now looking for another two symmetric cuts in benchmark interest rates of 25 bps each in the first half of 2015. The one-year deposit rate would fall to 2.25 percent and the one-year lending rate would be 5.1 percent.

Wang Tao, chief economist in China, UBS AG

The central bank's rate cuts and interest rate liberalization can be compatible.

However, these measures have had little impact on banks' lending rates, which are still largely priced off benchmark rates. As a result, real lending rates have remained high and increased again recently. A benchmark lending rate cut is the most direct and effective way to lower corporate borrowing costs.

The rate cut will help loosen financial conditions, but it does not necessarily imply a reversal of the PBOC's monetary and credit policy stances.

We think further rate cuts are likely in 2015, and their timing will be data dependent. We now think the benchmark lending rate may be cut by a further 40 to 50 bps by the end of next year.

As the rate cut was within our expectations, we maintain our 2015 GDP forecast of 6.8 percent and still see risk balanced more on the downside.

Zhu Haibin, chief economist in China, JPMorgan Chase & Co

The asymmetric interest rate cuts could put significant pressure on bank profitability. This may raise the question as to whether banks will maintain the distribution of lending rates around the benchmark rates or choose to float up the range.

It is a signal of a policy shift toward a more aggressive monetary easing. We expect at least one more rate cut in the coming quarters. In addition, possible quantitative measures include required reserve ratio cuts, targeted quantitative measures in the form of pledged supplementary lending, standing lending facilities, medium-term lending facilities and open-market operations, as well as possible adjustment in the loan-to-deposit ratio calculation.

Cai Hongbin, dean of Guanghua Management School

The weakness of China's economic growth was evident in easing consumer inflation, the 32nd month of declines in producer prices and slack import growth. However, the government has reacted overcautiously in terms of macroeconomic policy.

The recent central bank move to cut interest rates constitutes a reversal of the previously tight monetary policy. This is necessary but not enough. There is room for more expansive fiscal policy.

The central government set a national fiscal deficit goal of 2.1 percent of GDP for this year, which would work out to 1.35 trillion yuan ($220 billion). But there was a 609.3 billion yuan fiscal surplus in the first 10 months of this year. Taking the projected fiscal revenue in November and December into account, it means there will be room to spend 4 trillion yuan in the last two months of this year.

There is some concern that this extra liquidity would prop up the "old economy", represented by local governments, State-owned enterprises in industries with overcapacity and property developers, but that concern is misplaced under the current circumstances.

China cannot rely on macroeconomic policy to solve all of its problems. The first priority of the current macroeconomic policy should be to tackle looming problems including weak demand and the threat of deflation. Reform to solve long-term issues is in a different policy area.