JAKARTA (TheInsiderStories) – People’s Bank of China (PBoC) cut its one-year loan prime rate (LPR) to 3.85 percent from initially 4.05 percent as the country’ economy contracted for the first time in four decades. The central bank also cut its five-year rate to 4.65 percent from 4.75 percent.
This is the second time the policymakers has cut its rate so far this year. At the same day, China also reported its first negative year-on-year quarterly growth since the 1980s.
Gross domestic product in the first quarter of 2020 shrank 6.8 percent, compared with the same period last year, according to the national bureau of statistics. China’ fiscal first quarter revenue also fell 14.3 percent from a year earlier to RMB4.598 trillion (US$649.75 billion), attributing the decline to the COVID-19 outbreak and tax relief offered.
ING rated, China cut the one-year LPR by 20 basis points (bps), which is the last part of the “set” of rate cuts, including recent 20bps cuts in the 7D reverse repo and one-year medium lending facility. These policy rates, namely, the 7D reverse repo, one-year medium lending facility (MLF) and one-year LPR, are now at 2.2 percent, 2.95 percent, and 3.85 percent, respectively.
Is there a bottom to PBoC policy rates?
The PBoC has voiced that it does not agree with an ultra-low interest rate policy. As such, we do not expect the central bank to cut interest rates to a level that is ultra-low. But how low is ultra-low?
The 7D reverse repo has already gone beyond its previous historical low of 2.25 percent during 2016, and the same is true for the one-year MLF, which was at 3 percent during 2016. The one-year LPR is a new policy rate that replaces the benchmark lending rate.
Even the old one-year benchmark lending rate did not reach the current one-year LPR’ 3.85 percent level. In other words, the current policy rates are at their lowest levels on record.
Assuming that each cut from now on to the end of COVID-19 is 20bps, and there is a cut each month, then the 7D reverse repo will reach 1 percent in September (the last cut of the 7D reverse repo was on March 31). No one knows if the virus crisis will end completely by September, but it is almost certain that the damage to the economy will linger for another six months or so from now.
PBoC to rely more on RRR cuts
From the above assumption, September should mark the point when the PBoC hits the “ultra-low” interest rate level. After that, the PBoC may need to rely more on reserve requirement ratio (RRR) cuts than rate cuts.
The central bank may use RRR cuts more than rate cuts before September to delay its policy rates touching ultra-low levels. We expect the trade war and the technology war to return after COVID-19 cases subside in the United States.
By then, the Chinese economy will need another round of monetary policy support. There is a strong argument for the PBoC to save some ammunition for further rate cuts. That would mean the central bank may not cut the 7D reverse repo all the way to 1 percent by September.
But there is a problem relying on RRR. The RRR for small deposit companies and the smallest banks is already low at 6 percent. It would not increase loan growth a lot by cutting the RRR for the smallest banks.
China’ biggest banks face a RRR of 12.5 percent, which is still high. We believe that the central bank can cut the RRR of the big banks to release liquidity. If this were done together with fiscal support for government guarantees of small medium enterprises (SME) loans, then SMEs and employment could stabilize.
By the end of 2020, the PBoC policy interest rates and RRR are projected at 7D reverse repo 1.5 percen, one-year MLF 2.45 percent, one-year LPR 3.35 percent, RRR for the smallest banks 3.5 percent, and RRR for the biggest banks 9.5 percent.
Edited by Staff Editor, Email: email@example.com