What China's Rate Cut Means for Markets

Judging by the surge in share prices, particularly in the basic materials sector, the announcement that interest rates were being cut in China took the market by surprise

Daniel Rohr, CFA 25 November, 2014 | 1:53PM
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Markets cheered China's surprise rate cut that was announced last week, as lower borrowing costs should stimulate fixed-asset investment, which has been faltering in recent months. But the market’s enthusiasm overlooks a critical point: China hardly suffers a lack of investment. In fact, China's problem is just the opposite: too much investment.

Recharged investment outlays might boost headline gross domestic product, but it will also exacerbate excess capacity throughout the economy and add to the country's growing pile of bad debt. Long-term-focused investors should be concerned about Beijing's unwillingness to endure the short-term pain that it will take to put the economy onto a more sustainable growth trajectory. Another shot of whiskey will ultimately make this hangover worse.

The November 21 announcement from the People's Bank of China, or PBoC, included three changes. First, the central bank cut the one-year benchmark lending rate by 40 basis points to 5.6% from 6%. Second, it cut benchmark one-year deposit rates by 25 basis points to 2.75% from 3.0%. Third, it lifted the deposit rate "ceiling" banks are permitted to offer to 1.2 times the benchmark rate from 1.1 times. This had the effect of holding the deposit rate ceiling steady at 3.3%, despite the cut to the benchmark deposit rate.

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Daniel Rohr, CFA  is a senior equity analyst at Morningstar.