China’s monetary moves


WEB DESK: It is understood that China cannot remain aloof from the rest of the world when the maximization of growth through opening the economy has become its major objective. Mindful of this strategy, its central bank, the People’s Bank of China, took certain major decisions on 23rd October 2015, that could change the character of its financial landscape.

Official cap on interest rates for savers was abolished while monetary policy was eased further to address slowing growth in the world’s second-largest economy. In the area of monetary policy, interest rate was cut by 0.25 percentage point together with a drop of 0.50 percentage point in the reserve requirement ratio, ie, the amount of cash banks must keep with the central bank in reserves.

It needs to be noted that the move comes days before the leaders of the ruling Communist Party would meet to set the direction of the next Five-Year Plan and Chinese authorities seek a bigger international role for the Yuan, including the joining of exclusive club of the International Monetary Fund’s Special Drawing Rights (SDR) reserve currency.

Although, the above announcements would appear to be quite ordinary for a central bank operating in a free market economy, yet the measures taken by the People’s Bank of China would be seen with great interest all over the world and are expected to be interpreted in a different context. Accustomed to easy ways for a long time of an official cap, the new instructions would force bankers to compete for capital in a still state-dominated economy by offering savers a market-based rate of return for their money.

The decision will bring significantly more rivalry and innovation in the financial sector which was devoid of competition in the past and had in recent years seen a property and share price boom, only to face heightened risks when the bubbles burst. The new strategy would also help in better allocation of financial resources by allowing greater leeway for market forces to influence the level of deposits and loans in various sectors.

The biggest gainers would of course be ordinary depositors who could have more choices and earn better rates of return on their savings. The overall economy could also benefit through curbing consumption and generating higher level of investable resources which could be used more productively.

The cut in interest rate by 0.25 percentage point by its central bank shows that China is willing to undertake the needed monetary measures to revive growth to nearly or above 7 percent which has been the norm in the recent years. The easing of monetary policy and the use of reserve requirement tools that would allow more funds at the disposal of banks would ensure a higher level of credit to the private sector and greater economic activity in the country. Stock markets could, however, surge due to the rate cut.

There are hints from the European Central Bank that stimulus measures in the Euro area could be expected after December meeting. The People’s Bank of China’s move to cut the interest rate may have also been influenced by this anticipation.