If the US cuts, will China follow? As market expectations build for the first cut in US interest rates since the global financial crisis, attention naturally turns to the People’s Bank of China. Theoretically, lowering the benchmark US interest rate would provide scope for China to do the same, a move that could help the Chinese monetary authority to stimulate a  flagging economy

Whereas rising US interest rates were a constraint on the PBoC — it was feared that a narrowing gap between Chinese rates and their lower US counterparts would make renminbi assets relatively less attractive to hold, fuelling capital outflows — so falling US rates arguably provide more room for policy manoeuvring.  

The PBoC may trim the rates on the funds that it lends directly to institutions, reversing some of the “follow the leader” increases of the Fed’s 2015-18 tightening cycle. But a Chinese benchmark rate cut still remains unlikely. This is a nuclear option — growth is slowing but it is not collapsing, so the government would rather keep its powder relatively dry, avoiding any moves that might stoke speculation and drive up debt levels. 

However, an easing Fed could hasten a widely telegraphed move to what the PBoC calls a market-oriented interest-rate regime, using this shift to guide down interest rates to encourage borrowing by small groups. 

Changes to benchmark lending and deposit rates published by the PBoC once held considerable sway in the Chinese financial system. Rate adjustments would be decided by the State Council, the executive body on which the PBoC is just one voice, and announced without notice via the central bank website (Friday evenings, after the market closed, were popular with the central bank). 

But such rates have not been adjusted since the stock market crash of 2015. Instead, the authorities have relied on a mish-mash of market rate adjustments, administrative policy and cuts to the reserve ratio requirement to communicate policy and try to guide lending behaviour. 

The official lending rate, which has been at 4.35 per cent for nearly four years, still sits squat on the Chinese financial system, influencing much loan pricing while market-based interest rates trade below it. This is what the PBoC calls a “dual track” system of market-driven interest rates running alongside published official rates. 

Increasing noise from within the bureaucracy suggests this is poised for change. Rate reform has been ongoing for decades, but has been given recent impetus by the need to guide down the borrowing costs of small and medium-sized companies. These largely private companies have been hit by the crackdown on shadow finance and had their confidence knocked by the US-China trade war. 

As shadow finance is squeezed, bank lending has become even more important as a driver of China’s credit-hungry economy. But attempts to lower interest rates have not been successful. The China Banking and Insurance Regulatory Commission has said the average lending rate for small companies has fallen just 0.5 percentage points over the past year. 

The current plan involves ceasing publication of the benchmark lending rate, identifying an anchoring interest rate and calculating that rate based on market rates and monetary policy goals. The central bank has indicated that the deposit rate will continue to be published for now on concerns that removing this guidance will fuel destabilising competition among banks for customer funds. 

It will be a long time, if ever, before the Chinese central bank acts like its global peers

A leading candidate for a new benchmark reference rate is the loan prime rate, which was introduced in 2013 to reflect how much big banks charge their best clients. The influence of this rate in guiding loan pricing has fallen short of expectations because it too is under the sway of the official lending rate, failing to reflect conditions in the interbank market, which is the key source of non-deposit funding. 

Although many details still need clarifying, the broad intention is to have institutions pricing loans with reference to an interest rate that better reflects market liquidity conditions. Those conditions may be adjusted through explicit focus by the PBoC on the seven-day repo rate for deposit-taking institutions, known as DR007, with the end result that borrowing costs for small companies come down. 

Guiding down lending rates while leaving the deposit rate regime untouched suggests a squeeze on bank earnings. With balance sheets already under pressure as the economy slows, this raises the likelihood that interest rate reform will come with more cuts to the reserve ratio requirement to increase the supply of market liquidity and bring down bank costs. 

Reform has its limits, however. China’s banks will remain subject to lending quotas set in Beijing, while the authorities will continue trying to guide bank behaviour through quiet verbal or written communication, known as “window guidance”. 

Furthermore, loans will still be priced with a view to attracting customers — the fight for deposits is fierce — and meeting regulatory standards, including the quarterly macroprudential assessment, a regulatory review that includes ensuring banks have adequate deposit levels. 

It will be a long time, if ever, before the Chinese central bank acts like its global peers, announcing an independently made rate decision after a meeting whose schedule is publicly available. 

However, this year could see another incremental step towards that.  

— He Wei, Finance Researcher, FT Confidential Research

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.