Rates cut to ward off slowdown

Following other economies, China cut the benchmark deposit and lending rates by 0.27 of a percentage point yesterday to anchor its economy amid a worsening global financial crisis.

The reserve requirement ratio, or proportion of money commercial banks must set aside in reserve, will also be slashed by half a percentage point from October 15, the People's Bank of China said yesterday on its website.

The move will help prevent economic growth from declining as the global financial market turmoil is believed to further cut into world growth, which in turn will reduce demand for Chinese exports, analysts said.

The interest rate cut will take effect from today, when the cost of one-year bank loans will fall to 6.93 percent from 7.20 percent, while the benchmark one-year deposit rate falls to 3.87 percent from 4.14 percent.

The reserve requirement ratio would be 17 percent for big banks and 16 percent for others.

The State Council, China's Cabinet, also said it would scrap the 5 percent individual income tax on interest on savings starting today to boost domestic demand.

China began levying a 20 percent individual income tax on interest earnings in 1999 to encourage consumption and investment. The rate was slashed to 5 percent in August last year.

"It is appropriate for the authorities to lower the interest rates and reserve requirement under the current circumstances," said Dong Yuping, economist with the Institute of Finance and Banking at the Chinese Academy of Social Sciences.

If the international financial crisis worsens and leads to a drastic slowdown of the Chinese economy, Beijing may take further measures, he said.

As the US financial woes spread to other major economies, global stock markets have tumbled this week, with Japan's Nikkei average plunging 9.4 percent yesterday and the Dow Jones industrial average slumping for the fifth day on growing fears of a global recession.

China's domestic A-share market fell by more than 3 percent yesterday. Analysts said the latest cuts would help stabilize the stock market, which may have continued to slide without policy support.

In response to the growing crisis, the US Fed reduced its key rate from 2 percent to 1.5 percent. In Europe, which also has been hard hit, the Bank of England cut its rate by half a point to 4.5 percent and the European Central Bank sliced its rate by half a point to 3.75 percent.

The central banks of Canada, Sweden and Switzerland also cut rates. The Bank of Japan said it strongly supported the actions.

"The recent intensification of the financial crisis has augmented the downside risks to growth," the Fed said in explaining the coordinated action.

"The financial market developments will affect global economic growth and China must take action to cope with the challenge of external impact," Dong said.

Interest rate cuts alone, however, may not be very effective in invigorating the national economy, said Wang Tao, head of the China economic research institute of UBS.

The interest rate cuts show that policymakers may be facing reduced inflationary pressure, analysts said. The government is to release September inflation figures soon.

In August, inflation rose by 4.9 percent year-on-year, signaling an apparent downward trend after it reached a 12-year high of 8.7 percent in February.

However, some are worried that the inflation level may rise again in the coming months if energy prices are liberalized.

"Inflation could rebound in the coming months and the central bank cannot ignore that potential risk," said Ma Ming, economist with the Beijing Institute of Technology.
Questions:

1. Why is the Bank of China cutting interest rates, the reserve requirement ratio and scrap the individual income tax on interest on savings?

2.When did China start taxing income on interest on savings?

3. Name the three countries whose central banks also cut interest rates.

Answers:

1. To encourage consumption and prevent economic growth from declining.

2. In 1999.

3. Canada, Sweden and Switzerland.