By staff reporter Li Zengxin

China’s monetary policy makers have shifted their focus from curbing inflation to preventing an economic slowdown, said Shen Minggao, Caijing’s chief economist.

But in the eighth edition of Caijing Macroeconomic Weekly Review, Shen pointed out that, due to multiple internal and external uncertainties, the current monetary policy loosening by Beijing authorities is not enough to offset the severe tests of an economic slowdown.

“China needs a pro-growth fiscal policy,” he said.

On October 8, as part of a coordinated cut in interest rates by six of the world’s major central banks, the People’s Bank of China lowered its one-year benchmark deposit and loan interest rates by 0.27 percentage points. Interest rates for other terms were cut accordingly. The central bank also cut the required reserve ratio for commercial banks by 0.5 percentage points.

This was the second “double cut” by the central bank in less than a month, indicating that monetary policy indeed had been loosened in China.

Shen thinks internal and external factors were behind this policy shift. Externally, the likelihood of negative economic growth next year in the United States and the European Union is escalating. As a result, a downward trend for China’s exports will be hard to reverse in the short term. Meanwhile, domestic inflation pressure is easing, leaving room for monetary loosening.

However, in Shen’s view, the effectiveness of rate cuts may be limited. A new trend is that a market-based credit shortage in China is replacing a credit crunch tied to monetary policy. Initially, tight credit was mainly caused by strict loan quota controls, or “window guidance,” implemented by the central bank. But since the second half of this year, signs of a credit shortage tied to natural market reactions have emerged. Financial institutions have become reluctant to lend due to fears of default by borrowers with deteriorating prospects for profits.

Other factors also will constrain future monetary policy. First, interest rate cuts by central banks in major industrial economies will have a direct impact on China’s monetary policy. After the latest cut by the Federal Reserve, the U.S. federal benchmark interest rate fell to 1.5 percent. Further cuts may lead to a zero rate. As a result, global markets may again experience excess liquidity, and the amount of capital flowing into China may rise. If yuan appreciation fails to curtail the flow, excess liquidity could again drive China’s inflation rate higher.

Second, in the latest adjustments, China’s central bank applied “asymmetric” rate cuts. Concerned about the vulnerability of commercial bank profit growth, the bank may hesitate to continue this approach. The latest move reduced both deposit and lending rates by 27 basis points, while the Ministry of Finance abolished a 5 percent personal income tax on interest income. For a depositor, the effective savings rate was cut by 6 basis points, not 27. If the central bank continues asymmetric rate cuts to stimulate consumption, the profit margins of commercial banks -- which rely heavily on lending-deposit rate gaps -- will be further squeezed.

Third, rate cuts may encourage large enterprises to increase investments. The current credit shortage is mainly affecting small companies. Without a turnaround in external demand, increases in investment may worsen the problem of excess capacity.

With so many uncertainties, it’s currently difficult to precisely predict the central bank’s future policy changes, Shen said. But it’s clear that a comprehensive fiscal policy is needed.

If China is to release a “market rescue” plan, priority should be given to expanding domestic demand, especially by stimulating consumption. Unlike the United States and EU, which must stabilize equity markets to help their economies, Shen said that “saving the economy is the way to save the market” in China.

The latest Caijing Macroeconomic Weekly Review also contains a column entitled A Discussion with a Wall Street Professional: Challenges and Changes. In the interview, Chuck Prince, chairman of Stonebridge International’s board of advisors and a retired chairman of Citigroup, talks about the origin of the subprime crisis, the potential for supervision reform, and the future of financial innovation.