Shanghai resident Jeff Ding stands to save 75 yuan on his monthly mortgage but earn 270 yuan less on his 100,000 yuan one-year deposit if the People’s Bank of China cuts lending and deposit rates another 27 basis points as is widely expected.
The country is banking on more domestic spending to help it ride out its biggest economic crisis in three decades. But people like Mr. Ding, a 32-year-old civil servant, aren’t convinced they can afford to spend as if the economy is in good health.
The central bank has lowered the benchmark one-year lending rate from 7.47 per cent to 5.58 per cent through four successive rate cuts since the middle of September. Deposit rates are down from 4.14 per cent to 2.52 per cent.
And expectations are mounting that another round of rate cuts is around the corner, after the United States Federal Reserve slashed its target interest rate to near zero on Tuesday and the mainland’s central bank hinted repeatedly in the past few days at the possibility of rate cuts.
On Thursday, the bank’s governor, Zhou Xiaochuan, said the country faced pressure to cut interest rates in the near term. The pressure was not from the move by the US but from the fast falling domestic prices. “We will do things according to our own data,” Mr. Zhou said on the sidelines of a ceremony in Beijing to commemorate the 30th anniversary of the country’s economic reforms.
He said last month’s fall in annual consumer price inflation to 2.4 per cent from 4 per cent in October was bigger than most people had expected and left the index at a 22-month low.
Earlier this week, Mr. Zhou said the country would face rate cut pressure until the middle of next year and that any decision would depend on inflation.
The top leadership remains undecided on the consumer inflation target for next year. This year’s target is 4.8 per cent, as prices soared at the beginning of last year.
Some academics have projected a target of 3 per cent next year, a level suggesting no serious economic slowdown. However, many economists see a growing risk of deflation.
“Deflation is very, very bad,” said UBS chief regional economist Pu Yonghao. “Take Japan as an example. The nation was gripped by deflation for more than a decade. Recession was all it had.”
Any initial prospect of lower prices would be welcomed, but as they fell further, companies would struggle to generate profits and to service their debts. As a result, they would be forced to cut costs by any means, which would include cutting jobs. Rising unemployment would dampen consumer sentiment further in a vicious spiral of economic decline.
“This is why the central bank has been acting promptly to cut interest rates. Japan was slow to cut the rates until deflation became entrenched in the local economy, resulting in a lost decade,” said Mr. Pu.
The same ghost of deflation is looming on the mainland. The producer price index, a leading indicator for consumer inflation, rose 2 per cent year on year last month, the third consecutive lower increase since August, when the index rose 10.1 per cent, the fastest since 1996.
“Falling fuel prices, plus the success of Beijing’s measures to boost meat and food supply last year, is likely to lead to a fast deceleration in CPI in the coming months,” said Qu Hongbin, the chief China economist at HSBC Holdings.
The bank’s CPI projection for next year is minus 0.2 per cent, and Morgan Stanley’s is minus 0.8 per cent. China International Capital Corp expects CPI deflation at 0.7 to 1.3 per cent next year as an accelerated economic downturn exacerbates overcapacity and unemployment, coupled with falling international commodity prices.
Economists widely believe that the mainland will cut deposit and lending interest rates by 108 basis points and reduce the required deposit reserve ratio several times by the middle of next year to channel funds into the economy and encourage spending and corporate borrowing. The question is how effective the cuts would be.
“Unlike the US, China has sufficient liquidity in its banking system. The problem is whether the commercial banks are willing to lend massively,” said Lu Ting, an economist with Merrill Lynch.
Mainland banks lent 476.9 billion yuan (HK$540.9 billion) last month, nearly triple the 182 billion yuan lent in October and a more than fourfold increase over a year ago.
At the end of last month, outstanding yuan loans reached 29.57 trillion yuan, up 16.03 per cent year on year.
But economists have cautioned that banks were competing for attractive projects at the early stage of the 4 trillion yuan fiscal stimulus package announced early last month.
The enthusiasm to lend might fade with the cooling economy.
“Deflation is not always a bad thing. If it is due to a positive supply shock, it is ‘good’ deflation; if it is due to a negative demand shock, it is ‘bad’ deflation,” said Morgan Stanley economist Wang Qian.
“Our best judgment is that the potential deflation to emerge in the first half of next year will likely belong to the former. However, the challenge is to prevent deflationary expectations from getting entrenched, turning ‘good’ into ‘bad’ deflation; the latter carries far more serious consequences. This entails a strong, pre-emptive monetary policy response.”
Mr. Ding, the civil servant, says the economic slowdown has prompted him to shelve the kind of spending Beijing is hoping for.
“I have decided to postpone buying a second apartment next year,” he said. “I’ve also made up my mind to reduce dining out. I will not invest in the stock market. I will deposit idle money in banks as soon as possible before the next cut comes.”
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Beijing’s Rate Cuts May not be Enough
Shadow of deflation looms over mainland economy
Jane Cai
20 December 2008
Shanghai resident Jeff Ding stands to save 75 yuan on his monthly mortgage but earn 270 yuan less on his 100,000 yuan one-year deposit if the People’s Bank of China cuts lending and deposit rates another 27 basis points as is widely expected.
The country is banking on more domestic spending to help it ride out its biggest economic crisis in three decades. But people like Mr. Ding, a 32-year-old civil servant, aren’t convinced they can afford to spend as if the economy is in good health.
The central bank has lowered the benchmark one-year lending rate from 7.47 per cent to 5.58 per cent through four successive rate cuts since the middle of September. Deposit rates are down from 4.14 per cent to 2.52 per cent.
And expectations are mounting that another round of rate cuts is around the corner, after the United States Federal Reserve slashed its target interest rate to near zero on Tuesday and the mainland’s central bank hinted repeatedly in the past few days at the possibility of rate cuts.
On Thursday, the bank’s governor, Zhou Xiaochuan, said the country faced pressure to cut interest rates in the near term. The pressure was not from the move by the US but from the fast falling domestic prices. “We will do things according to our own data,” Mr. Zhou said on the sidelines of a ceremony in Beijing to commemorate the 30th anniversary of the country’s economic reforms.
He said last month’s fall in annual consumer price inflation to 2.4 per cent from 4 per cent in October was bigger than most people had expected and left the index at a 22-month low.
Earlier this week, Mr. Zhou said the country would face rate cut pressure until the middle of next year and that any decision would depend on inflation.
The top leadership remains undecided on the consumer inflation target for next year. This year’s target is 4.8 per cent, as prices soared at the beginning of last year.
Some academics have projected a target of 3 per cent next year, a level suggesting no serious economic slowdown. However, many economists see a growing risk of deflation.
“Deflation is very, very bad,” said UBS chief regional economist Pu Yonghao. “Take Japan as an example. The nation was gripped by deflation for more than a decade. Recession was all it had.”
Any initial prospect of lower prices would be welcomed, but as they fell further, companies would struggle to generate profits and to service their debts. As a result, they would be forced to cut costs by any means, which would include cutting jobs. Rising unemployment would dampen consumer sentiment further in a vicious spiral of economic decline.
“This is why the central bank has been acting promptly to cut interest rates. Japan was slow to cut the rates until deflation became entrenched in the local economy, resulting in a lost decade,” said Mr. Pu.
The same ghost of deflation is looming on the mainland. The producer price index, a leading indicator for consumer inflation, rose 2 per cent year on year last month, the third consecutive lower increase since August, when the index rose 10.1 per cent, the fastest since 1996.
“Falling fuel prices, plus the success of Beijing’s measures to boost meat and food supply last year, is likely to lead to a fast deceleration in CPI in the coming months,” said Qu Hongbin, the chief China economist at HSBC Holdings.
The bank’s CPI projection for next year is minus 0.2 per cent, and Morgan Stanley’s is minus 0.8 per cent. China International Capital Corp expects CPI deflation at 0.7 to 1.3 per cent next year as an accelerated economic downturn exacerbates overcapacity and unemployment, coupled with falling international commodity prices.
Economists widely believe that the mainland will cut deposit and lending interest rates by 108 basis points and reduce the required deposit reserve ratio several times by the middle of next year to channel funds into the economy and encourage spending and corporate borrowing. The question is how effective the cuts would be.
“Unlike the US, China has sufficient liquidity in its banking system. The problem is whether the commercial banks are willing to lend massively,” said Lu Ting, an economist with Merrill Lynch.
Mainland banks lent 476.9 billion yuan (HK$540.9 billion) last month, nearly triple the 182 billion yuan lent in October and a more than fourfold increase over a year ago.
At the end of last month, outstanding yuan loans reached 29.57 trillion yuan, up 16.03 per cent year on year.
But economists have cautioned that banks were competing for attractive projects at the early stage of the 4 trillion yuan fiscal stimulus package announced early last month.
The enthusiasm to lend might fade with the cooling economy.
“Deflation is not always a bad thing. If it is due to a positive supply shock, it is ‘good’ deflation; if it is due to a negative demand shock, it is ‘bad’ deflation,” said Morgan Stanley economist Wang Qian.
“Our best judgment is that the potential deflation to emerge in the first half of next year will likely belong to the former. However, the challenge is to prevent deflationary expectations from getting entrenched, turning ‘good’ into ‘bad’ deflation; the latter carries far more serious consequences. This entails a strong, pre-emptive monetary policy response.”
Mr. Ding, the civil servant, says the economic slowdown has prompted him to shelve the kind of spending Beijing is hoping for.
“I have decided to postpone buying a second apartment next year,” he said. “I’ve also made up my mind to reduce dining out. I will not invest in the stock market. I will deposit idle money in banks as soon as possible before the next cut comes.”
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