China Cuts Benchmark Rates

November 25, 2014 |Author: EGA Investment Strategy | Categories: Chart of the Week, Emerging Markets

China cuts benchmark rates. China cut benchmark interest rates for the first time since July 2012. The one-year lending rate was reduced by 40 basis points to 5.6%, while the one-year deposit rate was lowered by 25 basis points to 2.75%. This unexpected move suggests that authorities want to mitigate the potential risk of a financial crisis caused by slowing growth.

What does a rate cut mean? In the past, as chart of the week confirms, a reduction in interest rates would have resulted in higher credit growth. However, we do not think that will be repeated this time, given China's already high debt and high interest servicing burden as a percentage of Gross Domestic Product (GDP); and the central bank’s strict control over credit quotas.

What would be the impact? A short-term positive for China-sensitive assets such as commodities and property companies. Corporations and mortgage borrowers should also benefit through lower interest payments, but investors should not get carried away. We doubt this move alone would prevent a shift towards a slower pace of growth as China rebalances. The debt burden is large and excess capacity in many industries, particularly the real estate sector, still needs to be addressed.
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