China Prepared to Cut Rates Again as Deflation Fears Mount

China's Communist regime and its central bank are prepared to cut interest rates again and ease lending restrictions amid concerns that falling prices could spark a surge in debt defaults, business failures and job losses.

A senior economist at a government think-tank involved in internal policy discussions told Reuters that China's "top leaders have changed their views."

The unnamed economist said the People's Bank of China had shifted its focus toward broad-based stimulus and was open to more rate cuts as well as a cut to the banking industry's reserve requirement ratio (RRR), which in effect restricts the amount of capital available to fund loans.

The economist told the news agency: "Further interest rate cuts should be in the pipeline as we have entered into a rate-cut cycle and RRR cuts are also likely."

China Reforms Drive

Chinese lawmakers are worried that a sharp economic slowdown could hit employment and dent public support for reforms.

Beijing wants to roll out some painful reforms in 2015, including fiscal reforms to deal with a pile of local government debt, and the risk of pushing local governments into defaults could be balanced by lower interest rates.

China's central bank does not have the final word on adjusting interest rates or the value of the yuan. Monetary and currency policy is finally set by the State Council, China's cabinet, or by the Communist Party's ruling politburo.

The leadership is due to outline economic and reform plans for 2015 at a work conference scheduled for December, including economic targets which will be announced in parliament in March 2015.

Interest Rate Cut

The unexpected cut in rates on 21 February, the first in over two years, reflected a change of course by Beijing and the central bank, which had stuck with modest stimulus measures before finally deciding that a bold monetary policy step was required to stabilise the world's second-largest economy.

Bill Adams, senior international economist for PNC Financial Services, said in a note: "Today's Chinese interest rate cut seems designed to stimulate loan demand and prevent [the] Chinese slowdown from worsening. Recent Chinese economic data point to a weaker close to 2014, and suggest real GDP growth will likely slow to about 7% in 2015 from 7.4% in 2014."

"Cutting interest rates is a way for Chinese economic policy to cushion the impact of slower economic growth without reopening the credit floodgates.

"In addition to cushioning China's economy's move into slower growth, today's rate cut can also be understood as a reaction to China's very mild inflation. With the yuan mostly unchanged against the dollar in October and November, the recent drop in global commodity prices should pass through to lower Chinese inflation even more in coming months," Adams said.

"In addition, with China's inflation so low, today's rate cut could be argued to be maintaining a mostly unchanged real, or inflation-adjusted, interest rate. That is, today's decision lowers the benchmark interest rates in parallel to the recent decline in inflation.

Chinese corporate margins are under heavy pressure - producer prices of manufactured goods fell 2% in year-ago terms in the latest November release - so lower interest rates stabilize Chinese corporates' ability to service their debt," Adams added.

China cut the RRR for some banks in June but has not announced a banking-wide reduction in the ratio since May 2012.