PBOC Cuts Interest

Rate for One Year

Loans to Support Banks
Bloomberg News
February 17, 2020, 9:22 AM GMT+8 Updated on February 17,
2020, 3:50 PM GMT+8
China’s central bank provided medium-term funding to commercial lenders and cut the
interest rate it charges for the money, a move widely anticipated by analysts to cushion the
economy from the virus epidemic.

The People’s Bank of China offered 200 billion yuan ($29 billion) of one-year medium-term loans
on Monday. The rate was lowered by 10 basis points to 3.15%, the lowest since 2017. The central
bank also added 100 billion yuan of funds via 7-day reverse repurchase agreements, resulting in
a net 700 billion yuan withdrawal of money from markets as some 1 trillion yuan of reverse repos
matured on Monday.

The rate reduction is “in line with expectations, while the injection amount is relatively small as
interbank funding is sufficient after the new year,” said Zhou Guannan, an analyst at Huachuang
Securities Co. in Beijing. Zhou expects additional MLF funding to be supplied in March.

Since the outbreak of the coronavirus worsened in late January, China’s central bank and
government have announced small rate cuts, early bond sales, and various other targeted
measures to calm financial markets and support companies. So far, there’s not been a massive
increase in stimulus, although that may change if and when the coronavirus is brought under
control.

Monday’s rate cut is likely to be matched by a similar reduction in the loan prime rate, which is
the basis for pricing corporate and household loans. A Bloomberg survey showed economists
expect the rate for 1-year loans to fall by 10 basis points when it’s announced on Feb. 20.

China’s Fiscal Coffers Are Depleted Just as Virus Spurs Spending

Futures on China’s 10-year government bonds reversed gains after the operation, falling 0.27% as
of 3:11 p.m. in Shanghai. The yield on sovereign notes due in a decade rose 3 basis point to
2.896%.
“The injection is relatively small,” said Becky Liu, head of China macro strategy at Standard
Chartered Plc, adding the operation will reduce incentives to chase Chinese government and
policy bank bonds. “It means the PBOC does not intend to further lower front-end rates from
here.”

“I don’t think investors are overly worried about a lack of liquidity as it’s a clear trend that the
PBOC would ease,” said Zhou Hao, an economist at Commerzbank AG. “Any declines in bonds
resulted from today’s operation will create an opportunity for investors to buy more debt. The
10-year sovereign yield may fall to 2.8% in the coming weeks.”
 With the recent outbreak of the Covid-19 in China it has been reported that the country’s
economy transactions has fallen due to the lock-down. In accordance a demand-side policy has
been used involving an interest rate cut to support companies and financial markets encourage
investment and consumption in the economy. Interest rate refers to a proportion of a loan that is
paid as an addition to the borrower.

Assuming that due to the virus economic activities in the country slowed down as consumers
made less transactions and were probably not working, it can be said that before the interest rate
cut, the economy operated at point ‘Q1’ lower than the potential level of output ‘Qy’. After the
drop in interest rate levels, it is easier for households and firms to borrow money, enabling them
to continue transactions and for firms investment. The increase in consumption leads to a
rightward shift of the AD curve from AD1 to AD2, followed by a rise in the average price level
from P1 to P2. The attempt to shift AD curve is also an attempt to return back to the potential level
of output ‘Qy’.

Ideally, an interest rate cut will affect two components of aggregate demand, investment and
consumption. A drop in interest rate levels affects the demand side of an economy as the amount
of consumers spending increases. The borrowing of businesses to finance investment also
increases. So firms in china will be encouraged to borrow more to finance their production,
likewise households in China also get the incentive to increase consumption because of increased
money supply in the economy. By all this factors Aggregate demand increases followed by an
increase in total output. The economy is left in a better position

In reality, because of the outbreak, it can be assumed that households will not borrow money

since they go out less and are more interested in their safety. This is supported in the article by the

statement “funding to commercial lenders”, it is expected that only firms and producers will

borrow money at such period due to the increased cost of production and shortage in factors of

production and resources. However, during a crisis firms may also be closed down and therefore

there will be no need to take loans since there is no production. In essence, both firms and

households are not attracted by lower interest rates meaning that economic transactions remain

constant with no growth.

Although monetary policy measures are quick to implement as it is a decision carried out by

the central bank and only needs to be announced after some considerations, another possibility is

the time lag involved. It takes time before the policy takes effect, interest rate cuts for example

may take months before it has impacts on aggregate demand and further more real output(GDP).

Before the policy takes effect, situations may have changed, for instance the virus may have

subdued, and the interest rate may no longer be effective.

Furthermore in the case of recession, monetary policies can be ineffective. In a recession the

central bank may fear that lenders , both firms and households will be unable to pay back their

loans even with low interest rates for example. On the other hand, firms and households may even
decide to avoid taking loans. If consumers are pessimistic about the future, they may reduce their

spending and investment which in turns leads to lower aggregate demand.

Monetary policies may become inflationary if the policy lasts too long as consumption

continues to rise and in turn increase in aggregate demand. As aggregate demand continues to

increase price increases as well and eventually the continuous rise in price level will lead to a

demand pull inflation.

Interest rate cuts may not be effective in the case of an outbreak, it may be more effective to

use expansionary fiscal policies likes increasing government spending for research of treatment

and cure to the virus. New healthcare centers can be opened in more accessible locations. Overtime

with adequate funding a cure can be discovered. People get cured and economic activities

continues once again. Firms continue production and Households go out on daily bases, increasing

consumption. The cure could also be sold out to countries with same issues, raising more fund for

the government to correct any damage caused by the outbreak. The fund can be used to provide

subsidies to firms as they pick up after the outbreak.