Schroders: Chinese stimulus to boost sentiment, but not growth yet

The cuts, of 25bps and 50bps respectively, follow a disastrous few days on the equity markets, but we do not believe the PBoC wishes to reflate that particular bubble. However, the magnitude of the slump in the stockmarket is likely to have a negative impact on sentiment, especially given a weak economic environment (we saw a much softer-than-expected manufacturing Purchasing Manager’s Index (PMI) print last week).

In addition, the change in exchange rate policy which resulted in a devaluation of the renminbi (see Schroders Quickview: Large yuan depreciation not on the horizon) has seen capital outflows, which in turn have reduced liquidity and led to tighter monetary conditions. By cutting the RRR, alongside recent market operations, this liquidity is restored and lending supported. Interest rate cuts, meanwhile, should reduce borrowing costs for existing borrowers, particularly households and state-owned enterprises.

Will this stimulus drive a growth rebound? We are doubtful. As mentioned, the RRR cut likely just restores lost liquidity. The rate cut, while helpful, probably just forestalls defaults, rather than encouraging investment in an economy beset by deflation, overcapacity, and high debt levels. Further, previous rate cuts have done little to lower borrowing costs for new borrowers, as bank interest margins have been squeezed by asymmetric effects on deposit rates compared to lending rates. This asymmetry has eased thanks to further deposit rate liberalisation, but banks may still seek to restore some of their lost margins, particularly given their mandatory participation in the local government debt swap.

In short, the stimulus measures should help market sentiment, but we do not expect a resurgent China as a result.