By staff reporter Li Zengxin

By joining other central banks around the world with coordinated interest rate cuts in October, the People’s Bank of China anchored what many experts say is a rate-cutting trend designed to protect the domestic economy from the current storm in the global market.

But what China’s export-reliant economy really needs in the face of slowing GDP growth and a possible recession overseas, experts say, is a comprehensive fiscal package that includes tax cuts and other measures to stimulate consumer spending.

Beijing’s central bank lowered the benchmark one-year deposit and lending rates by 27 points, effective October 9, and the required reserve ratio for commercial banks by five points, effective October 15. At the same time, the Ministry of Finance abolished a 5 percent personal tax on interest income.

The central bank’s September 15 move was its second “double cut” in less than a month. Unlike rate cuts made that same day by central banks in the European Union, the United States and other countries, the cuts made by the central bank were not aimed at boosting equity markets. Rather, they were specifically designed to save the Chinese economy from a slowdown.

China’s state-owned investment bank, China International Capital Corp. (CICC), has predicted the central bank will continue to cut the lending rate over the next 12 months. Its forecast is for reductions between 81 and 135 basis points for the lending rate, and 27 to 81 basis points for the deposit rate.

Meanwhile, the government’s required reserve ratio for commercial banks should fall by 350 to 550 basis points, CICC said, while the yuan’s appreciation against a basket of foreign currencies should be from 2 to 3 percent.

Encouraging the latest adjustments – and further cuts expected in the future – are justifiable fears that the real economy is slowing, said Ha Jiming, CICC’s chief economist.

Darker Forecast

In general, China’s exposure to the worldwide financial crisis has been limited. The U.S. Treasury said China holds US$ 519 billion in T-bonds. It also has between US$ 300 billion and 400 billion in bonds issued by U.S. mortgage giants Fannie Mae and Freddie Mac, according to CICC. In addition, Chinese banks held US$ 670 million in bonds with the bankrupt investment bank Lehman Brothers, while the government’s sovereign wealth fund China Investment Corp. held a 9.9 percent stake in Morgan Stanley.

Nevertheless, several global investment banks and institutions have lowered their forecasts for China’s GDP growth. Goldman Sachs adjusted its growth projection to 9.8 percent from a previous 10.1 percent for this year, and to 8.7 percent from previous 9.5 percent for 2009. UBS cut its forecast to 8 percent from 8.8 percent for next year. And Deutsche Bank China economist Ma Jun expects China’s growth to slow to 8.4 percent in 2009, and slide further to 7 percent in 2010.

The more pessimistic predictions are based on threats facing Chinese business in the United States and the European Union, which accounted for more than 40 percent of the nation’s exports. With recessions looming in the United States, EU and Japan, exports from China may slow significantly.

China’s real estate sector has softened as well. The National Development and Reform Commission reported that, for the first time, average home prices in China’s largest 70 cities fell in August compared with the same month 2007. The number of cities with falling real estate prices increased to 25 in August, from just five in April.

“China was unscathed by the (global financial) crisis, but it is not immune to the downturn,” Morgan Stanley’s China economist Wang Qing told Caijing.

Policy Change

China’s challenges are radically unlike those in the United States and the EU, where a meltdown that started in the financial sector led to government “market rescue” packages, said Shen Minggao, Caijing’s chief economist.

Of course the central bank’s “double cut” decision sent a strong signal to build market confidence, said Wang Tao, China economist at UBS. The bank may continue following this “asymmetric” style of rate cuts to benefit the real economy and the market, she said.

But the central bank’s measures are not a panacea for problems such as a credit shortage and long-term profitability declines for companies.

No wonder China’s stock market was lukewarm to the policy adjustments. On October 9, the day after the rate cut announcements, share prices on the Shanghai and Shenzhen bourses rocketed at the opening but soon curved downward. The Shanghai composite, Shenzhen and CSI 300 indexes finished the day lower.

Beyond rate cuts, experts say, China needs a program based on policy changes to improve the economy. Once the economy is safe, market improvements will follow.

“Policy adjustment is crucial for China,” said Zhu Jianfang, a macroeconomic analyst at Citic Securities. Without a pro-growth policy package, Zhu warned, China’s 2009 GDP growth rate may fall to 7.5 percent – a so-called “hard landing.”

Options on the Table

A fiscal policy package that stimulates domestic spending, many analysts say, may start with reforming the value-added tax system next year and later include lowering personal income tax thresholds.

Wang said China should relax quotas for loans to commercial banks. Some economists advocate government debt to finance infrastructure construction, although most economists favor a controlled program that does not mimic the large-scale, costly construction campaigns of 1998. The focus of additional government spending should be to lift household incomes and improve social conditions as well as healthcare systems, said Huang Yiping, an Asia economist at Citigroup.

To stimulate domestic consumption, Shen said the government should launch a kind of “domestic demand reform and consumption stimulation” scheme. “The key for this is to increase household income,” he said.

A scheme could encourage middle class consumption through tax cuts, stimulate rural consumption by relaxing grain price controls, and provide government assistance to the urban poor.

Regardless of the details, a consensus among experts is that China urgently needs to shift from export- to domestic-driven growth. Shen said a transition won’t be easy, but at least there should be fewer concerns that inflation would worsen if tax cuts are made to stimulate consumption.

Gao Shanwen, chief economist at Essence Securities, thinks China’s inflation rate will fall rapidly as prices of international commodities decline, relieving many companies of profit pressure. And as export growth falls, exporters may shift to domestic markets, boosting supplies and keeping prices in check.

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