Stimulus With Chinese Characteristics

You can never be too careful.

Photographer: Tomohiro Ohsumi/Bloomberg

China's central bank startled investors last week with an unexpected cut in its benchmark interest rates. The markets, as usual, overreacted. Nonetheless, the cut draws attention to a genuinely difficult problem for the global economy: what to do about China's fading and unbalanced expansion.

The People's Bank of China cut the one-year lending rate on Friday from 6 percent to 5.6 percent, and the one-year deposit rate from 3 percent to 2.75 percent. It was the first such stimulus in China since 2012, and shares and commodity prices rallied all over the world.

The announcement does mark a change of approach by the central bank. Up to now, it has aimed to support growth by providing liquidity industry by industry, rather than by cutting economy-wide interest rates.

Normally when China departs from this approach and cuts rates, it signifies a sharp change in policy. Friday's cautiously calibrated change wasn't that. The cut was too modest to make much difference. Now that policy makers have signaled that interest rates are again at their disposal, however, there may be more cuts to come.

The central bank's announcement that banks would be given a bit more freedom to set their own deposit rates was notable, too. It fits with the leadership's promise last year to give market forces a bigger role in the financial system.

For years, China has capped bank-deposit rates, which tends to hold down consumption (by giving savers less money to spend) and inflate investment (by making it cheaper for firms to borrow). The result has been a pattern of unbalanced growth, increasingly tied to investments of dubious value. Friday's changes, taken together, suggest that borrowers, struggling with heavy debts, will see a slightly bigger cut in rates than depositors. That combination should increase consumption modestly.

The test for the government and its officials at the central bank is to take this adjustment further and support growth while acting to redress the imbalance. Renewed reliance on debt-financed investments with no economic merit would only make the economy more fragile and risk turning the slowdown into a collapse. The trouble is, supporting growth in ways that don't run that risk is a new experience for China's leaders.

China's slowdown is serious by its own standards -- but not, as yet, alarming. Figures released earlier this month show that factory output rose 7.7 percent in the year to October -- the slowest in five years but still an expansion that other economies would be grateful for. Inflation is low, so there's scope both for further interest-rate easing and for additional moves to liberalize the financial system.

Last week's move, modest as it was, confirms that China's policy makers are willing to innovate, albeit cautiously. That's good. Engineering a soft landing for China is in everybody's interests.

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