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China slashes interest rate to spur growth

China announced its biggest interest rate cut in 11 years on Wednesday to spur private borrowing and support a multibillion-dollar stimulus package to boost slowing economic growth.
/ Source: The Associated Press

China announced its biggest interest rate cut in 11 years on Wednesday to spur private borrowing and support a multibillion-dollar stimulus package to boost slowing economic growth.

The 1.08 percentage-point rate cut — the fourth cut in three months — reflects the government's urgency about raising private consumption and investment to supplement state spending on the stimulus package.

"This is the most aggressive monetary easing in recent years and should bode well for China's market performance," said Jing Ulrich, chairwoman of China equities for JP Morgan & Co., in a report to clients.

The 4 trillion yuan ($586 billion) stimulus aims to insulate China from a global slowdown by injecting money into the economy through spending on new highways and other public facilities. But its ultimate goal is to increase consumer spending, which a rate cut is meant to encourage.

Beijing is trying to shore up consumer and investor confidence and reverse a sharp downturn in growth. China's economy is expected to expand by at least 9 percent this year, down from 11.9 percent last year. But communist leaders worry about rising job losses — especially in export industries hit by weak global demand — and possible unrest.

China has avoided a big hit so far from the global financial crisis because its banks are healthy and exports strong. But conditions are expected to worsen in coming months as export demand weakens and growth in real estate and other domestic industries slows.

Just this week, the World Bank cut its forecast for China's growth next year from 9.2 percent to 7.5 percent, the lowest level since 1990.

Beijing had been rumored to be considering a rate cut and Chinese stock markets fell Monday after one failed to materialize over the weekend. The cut Wednesday was announced after markets closed. The Shanghai Composite index, down two-thirds from its peak in October 2007, edged up 0.5 percent to 1,897.88.

Also Wednesday, the central bank cut the amount of money commercial banks must set aside as reserves, expanding the pool available for lending.

The moves are meant to "promote stable credit growth," the People's Bank of China said on its Web site.

Interest on a one-year loan will fall to 5.58 percent, effective Thursday, while interest paid on deposits will fall to 2.52 percent.

The rate cut was several times the size of other recent cuts on Sept. 15, Oct. 8 and Oct. 29, which were only 0.27 percentage points.

It was China's biggest rate cut since 1997, according to Standard Chartered economist Stephen Green. But he cautioned that rate cuts alone might not be enough to trigger a wave of house purchases and corporate investment.

"To be honest, rate policy in this environment is a marginal factor — businesses think about possible returns on investments, and households will look at house price prospects," he said in a report.

"We have almost exhausted traditional monetary tools now," Green said. "What happens next is mostly fiscal policy and encouraging the banks to lend."

The amount that China's biggest banks must hold in reserve will fall by 1 percentage point to 15.5 percent, effective Dec. 5, the bank said. The minimum reserve for smaller banks would fall by 2 percentage points to 14.5 percent.

The change frees up 360 billion yuan ($53 billion) in additional money for lending, according to Green.

The rate cut will lower borrowing costs for state companies, which are expected to provide a big share of the promised investment in the government stimulus.

A key issue will be whether banks are willing to lend more. They have tried to shield themselves from global turmoil and the slowing real estate industry by cutting back on lending to exporters, developers and small companies.

"The degree of benefit realized from China's monetary stimulus will hinge on whether banks increase their lending to the most troubled sectors of the economy," Ulrich said.