Join our daily newsletter At The Bell to receive exclusive market insights
The People’s Republic of China has officially reduced its one-year (1Y) prime loan rate from 3.55 per cent to 3.45 per cent.
The 1Y prime loan rate is the key lending benchmark used by the People’s Bank of China (PBOC) for new bank loans to both homes and businesses, a practice in place since August 2019.
The rate is determined based on a weighted average rate from 18 different commercial banks in China, with these banks submitting rate quotations to an interbank funding centre each month.
The PBOC has taken this step in an effort to stimulate economic growth, a move that the market has been eagerly awaiting.
Why does China need stimulus?
At the beginning of 2023, the market was confident that China would recover from two years of lockdowns and experience an economic boom. However, this expected boom never materialised, and as of August 9, the country officially entered a state of deflation.
Deflation indicates a slowdown in the Chinese economy, as evidenced by declining exports and imports. Simultaneously, Chinese services inflation remains high.
Deflation means China is buying less from other countries
Recent data shows that the USA imported more from Mexico than from China for the first time in 20 years. Chinese economic data for the second half of 2023 has been disappointing, with declines in retail sales, industrial production, and house prices, which started falling for the first time this year.
New concerns facing China’s construction sector – much like those which hit Evergrande in 2021 – have seen contagion issues spread into the country’s finance sector.
It’s worth noting that two years after its troubles began, Evergrande officially filed for bankruptcy in the US last week.
Country Garden an elephant in a coal mine
China’s largest builder, Country Garden, failed to make bond payments earlier this month and now has until September to meet its obligations, or it could trigger another wave of investor panic. Furthermore, Country Garden has been delisted from the Hong Kong Stock Exchange.
Reports have also emerged of a protest outside the headquarters of China’s Zhongrong Bank after it failed to make repayments to investors.
Additionally, there are allegations that Chinese stock market operators are urging onshore investment firms not to sell off Chinese equities, indicating concerns within the financial sector.
A third set of loan rate cuts in as many months
As recently as Tuesday, August 15, the central bank already reduced medium-term loan rates by 0.15 per cent after a 0.10 per cent drop in June.
Knight Financial Advisors Director Jason Featherby said last week that he believed these small cuts would not be sufficient to effectively stimulate the economy.
“The 10 basis points cut – point one of a per cent – it’s putting a band-aid over a pretty big problem … China represented 40 per cent of the world’s growth over the last decade or so, if not longer, so if they don’t get the confidence of their people to go and invest again, I’m not sure it’s going to end well.”
While spending remains down in China, there is the more optimistic observation that household savings ratios are on the rise again.
Stimulus is inevitable, but when
Mr Featherby believes stimulus is inevitable, but the timing and manner in which China decides to implement it remain uncertain. It is likely to be determined solely by China, without necessarily factoring in Australia’s concerns regarding Country Garden’s situation and the impact on iron ore sales.
Iron ore has played a crucial role in China’s rapid industrialisation throughout the 21st century, and Australia, in particular, has benefited significantly. Most of Australia’s lithium and iron ore exports are destined for China.
However, China’s reduced demand is evident, as reflected in futures price volatility for iron ore. Traders will be closely watching upcoming monthly inflation and retail sales data from China for any early signs of improvement.
Should Country Garden miss its last-chance bond deadline in September, further challenges may lie ahead.
