We know the People's Bank of China is willing. Is it able?

Photographer: WANG ZHAO/AFP/Getty Images

What China's Rate Cut Will and Won't Do

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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China-related headlines dominate this morning’s financial media, and understandably so. The country’s surprise decision to cut interest rates, together with strong tech earnings, has contributed to an impressive surge in stocks in Europe and the U.S.

Only a few weeks ago, concerns about China's economy led to a sharp fall in equity markets around the world, so it should come as no surprise that global investors welcome a new monetary stimulus there. After all, the country’s economy is large, systemically important and a notable driver of corporate earnings for many multinational corporations. Yet it is important to remember what can and cannot be achieved by this policy move.

  1.  China’s interest-rate cut will help loosen monetary conditions there, improving the prospects for financial assets in the country.
  1.  By helping domestic consumption at the margin and by alleviating some debt concerns, today’s action by the Chinese central bank could also facilitate structural reforms that are essential to stabilize China's economy and restore growth momentum.
  1. The interest-rate cut is yet another indication that a large percentage of the world's central bankers are still both willing and able to inject liquidity in response to economic and/or market air pockets.
  1. These undoubtedly strong signals should not obfuscate, however, the considerable challenge China faces in using monetary policy to fuel economic growth. Officials are obviously willing to pull the levers of monetary policy, but that does not guarantee any effectiveness.
  1.  The connection between China's interest rates and economic growth is far from perfect. The nation needs tricky structural re-orientations over the course of years, with a significantly greater dependence on domestic consumption. And China's financial sector is already burdened by pockets of excessive indebtedness.
  1. Given the country’s far-from-open capital account, the effect of a Chinese rate cut on the global economy is far from clear. This is in contrast to Europe and the U.S., where any liquidity injection would normally spill over to foreign markets.

Markets are right to welcome the China news as confirmation that the Fed, the ECB, the People's Bank of China and other central banks remain their best friends. But what markets really need is a transition away from this liquidity assistance, toward genuine growth.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story:
Philip Gray at philipgray@bloomberg.net