China: Addressing Economic Weakness

Published on August 19, 2019

China’s Premier Li Keqiang presided over a State Council Executive Meeting in Zhongnanhai, Beijing, on Friday, the first day back from the traditional Beidaihe summer retreat of China’s top leaders.

*** At the meeting, Li endorsed a plan that was unveiled the next day, on Saturday, for the People’s Bank of China to improve on the Loan Prime Rate (LPR) mechanism in order to both further reform the country’s interest rate market mechanism, and, perhaps of more immediate importance, to get cheaper funding out to Small and Micro Enterprises (SMEs). While markets are still not sure what the exact impact of these changes might be, senior sources in Beijing expect that new loans priced as of tomorrow, Tuesday, through the LPR could carry a discount of between 25 and 50 basis points from current benchmark 1-year and 5-year lending rates. ***

*** And on the fiscal side, in response to growing downside risks, Li also repeated at the meeting the State Council pledge to adopt a series of measures in the second half of the year that include more than 1 trillion yuan in tax and fee cuts, and the acceleration of the issuance of more than 900 billion yuan of special local government bonds and incentives to boost employment. ***

Growing Downside Risks

From what we understand, Li downplayed on Friday some of the temporary factors that have been cited to explain away the recent weak economic readings – such as adverse weather and the payback from a bump in June auto sales in advance of new emission standards that took effect in July – and instead fully acknowledged that China’s economy was showing real signs of a slowdown.

Li stressed that a combination of monetary, regulatory, and fiscal policy would be implemented to facilitate “a greater role by the guarantee system to reduce financing costs facing the real economy in a concrete way.” That goal includes cutting the financing rates for small and micro enterprises (SMEs) by 1 percentage point this year.

In order to do that, starting tomorrow, August 20, China’s National Interbank Funding Center will publish an LPR rate at 9:30 a.m., to be repeated on the 20th day of each month.

The LPR, not unlike the now-disgraced LIBOR, will be determined by banks that will tack a few basis points onto their cost of funding from the central bank in the open markets.

But to ensure that the new plan is implemented well, enterprises will be encouraged to report bank practices of setting this “implicit interest rate floor” as needed to market regulators, and to self-disciplinary industrial bodies.

In practice, the average interest rate for loans to SMEs stood, according to Chinese economic officials, at 6.82% through the first half of the year, down 0.58% from the rates paid in 2018. 

As Premier Li and the State Council have set a goal of cutting the average lending rate for SMEs by 1 percentage point this year from last, that implies a cut of roughly another 50 basis points for the second half of the year is in the works.

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