BEIJING China's surprisingly sharp and sudden drop in credit has strengthened the case for the central bank to cut interest rates, but policy insiders believe it will be reluctant to take more aggressive steps and for now will stick to more targeted measures.
While July data pointed to an economy that is struggling, the People's Bank of China (PBOC) remains concerned that pushing more money into a system already flush with cash may lead to a further build-up of debt and encourage speculative activities, rather than boost the real economy.
Economists at top government think-tanks involved in internal policy discussions believe the PBOC will instead continue to try to reduce the cost of borrowing in other ways, while coaxing increasingly risk-averse banks to keep credit flowing at affordable levels to avert a deeper slowdown.
"It's necessary to cut interest rates," said an economist at the National Development and Reform Commission (NDRC), the country's top economic planning agency.
"But we must take some time to see whether the current targeted policy measures will work," said the economist, who requested anonymity due to the sensitive nature of the topic.
A strong policy signal such as an interest rate cut, which would mark a fundamental shift from its current policy stance, would also require approval from the country's top leaders, who may want more time to see if a raft of support measures announced this spring will yield further results.
"We do not expect meaningful stimulus from Beijing in the current economic environment. The threshold of the current administration is much higher than the Wen Jiabao regime when it comes to launching stimulus," Credit Suisse economists Dong Tao and Weisheng Deng said in a research note.
"If the much more unfriendly growth in the first quarter of 2014 failed to trigger social instability, we do not see why it should happen now."
Lian Ping, chief economist at Bank of Communications - the country's fifth-largest lender, said the central bank will want to see whether credit and economic growth continue to slow, before considering bolder policy action.
"It's hard to see a big policy change based on one single month's data. Even if there is a policy shift, it may happen in October - they need time to watch the trend," he said.
Chinese banks made 385.2 billion yuan ($62.53 billion) in new yuan loans in July, down 64 percent from June, while total social financing, a broad measure of liquidity in the economy, tumbled 86 percent to 273.1 billion yuan, the lowest in nearly six years, data showed on Wednesday. [ID: nL4N0QH1O4]
In a rare statement accompanying the data, the PBOC sought to reassure markets that credit and financing growth was still reasonable and that it had not changed its monetary policy, arguing that July's credit data was distorted by seasonal factors after a lending binge in June and noting that the pace of lending in early August was back to normal.
But the central bank conceded demand for loans was weakening, while the amount of bad loans continued to rise.
Some economists have argued that the central bank's monetary policy tweaks so far may not have been effective in bringing down real borrowing costs, as even state banks appear to be baulking at taking on more exposure in a softening economy.
A recent survey by Standard Chartered indicated many property developers were finding it tougher to access funding through banks or trust loans, while borrowing costs were rising.
"Despite the PBOC's preference for targeted easing, through rediscounts, relending and PSL, we have argued that broad-based interest rate cuts would be a better policy," Jian Chang, China economist at Barcalys Capital, said in a research note.
Pledged Supplementary Lending (PSL) is a new policy tool that the PBOC has been reportedly experimenting with to help guide medium-term interest rates, even as it injects more cash into money markets to keep liquidity conditions ample.
"Liquidity tools have apparently seen their effect very much neutralised, so the PBOC may shift to pricing tools," said a senior trader at a major Chinese state-owned bank in Shanghai.
The central bank could also opt to cut lending rates to encourage more corporate borrowing, while keeping deposit rates steady to ensure savers did not withdraw their funds, which would leave banks with less money to lend, the trader said.
The central bank has already reduced reserve requirements for some lenders to channel more credit towards small firms, which are vital for growth and job creation, and some economists say it should extend the move to all banks nationwide.
Changes in the so-called RRR do not need cabinet approval.
The government, for its part, has quickened fiscal spending on railway expansions and public housing, and banks have to lend to such projects.
Still, while anecdotal evidence suggests the price of money has risen for many borrowers, central bank data argue otherwise. They showe the weighted average lending rate fell 22 basis points in the second quarter to 6.96 percent.
China has freed up bank lending rates, but lenders still refer to benchmark rate when they charge clients. The one-year benchmark lending rate stands at 6 percent.
The PBOC last cut interest and deposits rates in 2012.
To be sure, inflation pressures in China remain benign, in part due to considerable slack in the economy, giving both the government and the central bank plenty of latitude to ease policy further if conditions sharply deteriorate.
But policymakers vividly remember the unwanted side-effects of a massive stimulus programme during the 2008/09 global financial crisis, which left local governments saddled with mountains of debt and ignited years of property speculation.
The real root cause of China's high funding costs is related to structural distortions, which could blunt the impact of any rate cuts, analysts say.
China's state-owned enterprises (SOEs) and local governments have sucked up the bulk of bank loans regardless of the level of borrowing costs, and banks are more willing to lend to SOEs as they believe they are implicitly guaranteed by the central or local governments from defaulting.
The fact that SOEs take up most funding resources crowds out the needs of private owned companies. Some state firms even re-lend their loans to small firms at higher interest rates.
"Monetary policy will be effective to bring the funding cost down should high funding costs are the result of mismatch between supply and demand," Tommy Xie, an economist at OCBC Bank in Singapore, wrote in a research note.
"Unfortunately, China is facing more complicated issues as its high funding costs could be partly attributed to structural problems, which may not be addressed by monetary policy."
(Additional reporting by Lu Jianxin in Shanghai; Editing by Kim Coghill)