Another small rate cut from the People’s Bank of China (PBOC) simply will not move the Chinese economy. Even if these remarkably modest cuts had been bolder, monetary action is not what China needs. Instead, China’s economy cries out for a correction of past policy mistakes, mistakes that have destroyed the confidence of Chinese households and private businesses, large and small. It is sad that Beijing seems not even to know what is needed. Even if it did, it is not clear that the nation’s leadership could take the necessary steps.
Beijing’s partial awakening to the economy’s urgent needs seems to have occurred late last year. This past January the authorities finally abandoned its severe “zero-Covid” lockdowns and quarantines. For a brief while, China’s economy seemed to have responded, but by spring the growth momentum began to fade. In response, the authorities instituted a program of infrastructure spending of the sort it has used many times in the past and scheduled it to unfold over months. Beijing also prevailed on the PBOC cut interest rates in June. The hope was that lower rates would induce consumers to spend more and businesses to borrow and invest for expansion. The action was miniscule. According to the PBOC website the one-year loan prime rate and the five-year rate each fell by 10 basis points to respectively 3.55% and 4.20%. These moves had no appreciable effect. Then in August the PBOC took even more timid action. It has cut only one rate to bring the prime loan rate down to 3.45%.
It verges on the amazing that anyone – even China’s leadership – could expect anything from such modest rate cuts. Consider that China has recently experienced deflation. July showed a modest drop in general price levels of 0.3% at an annual rate. Any borrower then pays 3.45 percent for a one-year loan and repays it with yuan worth 0.3 percent more in buying power. The real rate of borrowing then comes to 3.75 percent, hardly an incentive to borrow, either to support consumption or to expand a business operation. Even in the modest rates of inflation seen since, these rates hardly provide an incentive to borrow.
It is far from apparent whether China’s economy would have responded had the PBOC acted more aggressively. Much of the private economy – households and businesses – suffers from a severe crisis of confidence that makes all unwilling to take risks or extend themselves in any way, much less make plans for investing in business expansions. Part of this problem has grown out of the burdens imposed for years by Beijing’s zero-Covid policies. Its seemingly arbitrary but nonetheless severe quarantines and lockdowns destroyed business plans and instilled in all an uneasiness about whether they could even secure a regular income. At the same time, the collapse of the residential property market has depressed real estate values, the quintessential asset for most Chinese. According to Beijing’s National Bureau of Statistics, home prices had fallen for 16 straight months up to last December, and though they seemed to stabilize earlier this year, they began to fall again in spring.
In the face of such economic depressants, it will take more than a modest interest rate cut to induce people and managers to become more aggressive about spending and expansion. But there is still more holding back China’s economy. Beginning in 2021, President Xi Jinping began to talk about recapturing China’s Marxist principles. He made his position abundantly clear at the 2022 party conference, asserting that less Marxist past was needed to catch up with the developed world, but now that China had established itself, it could return to those roots. If this were not enough to make private businesspeople wary, he went on at time to accuse them of bad faith for following profit opportunities instead of the Communist Party’s agenda. Now that Xi can see the need for private business investment and expansion, he has changed his tune, referring to private business in his 2023 new year address as “our own people.” But both households and businesses remain wary, the former saving instead of spending and private business actually cutting back on its capital spending during the past year.
Clearly, Beijing needs to do more. The PBOC should urgently make more substantial interest rate cuts. Other authorities in Beijing, including President Xi, need to offer businesses assurances that they will not turn on private owners and managers again at a later date. That will take a commitment to allow businesses to follow the business
opportunities as they see them not according to a centralized plan such as Beijing has insisted on for some time. Such a change will take more imagination than Beijing’s policy makers have ever exhibited. Indeed, such a change would seem to run counter to Beijing’s DNA. In the meantime, China’s economy remains a bad bet.
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