China’s central bank on Monday cut interest rates for the first time since 2002, a move likely to have been sparked off by the unravelling of big US investment banks, Lehman Brothers and Merrill Lynch.
The one-year lending rate was cut by 0.27% to 7.2%. The reserve requirement ratio for smaller banks was also cut by 1%.
While liquidity concerns loom large behind the decision, it can complicate inflation management. Inflation has fallen to 4.9%, the lowest since June 2007. This has been due to the recent cooling in export growth and lower food prices. But with a lending rate cut, inflationary pressures could rebound.
The choice is interesting. World Bank economist Louis Kuijs had argued for fiscal loosening instead of a monetary one, if China is to rebalance its heavy industry, capital-intensive economy to a service and labour-intensive one. As a result, this may be a temporary policy blip in view of global events that China can’t control.