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Despite slowing, economic meltdown far from certain

By Yi Xianrong (Global Times)

08:31, July 24, 2012

A drop in new loans, sagging factory output, an unexpected interest rate cut, a decrease in imports and a scaling back of GDP growth projections - these are just a few of the macroeconomic indicators that have been trotted out recently by commentators in order to argue that China's economy is headed for a cliff.

While growth readings are certainly down for several major indicators, this does not necessarily prove that the nation's economy is on the verge of disaster. Although this is not the ideal forum to dissect all of the challenges facing China's economy at present, if one takes a closer look at some of these indicators, the country's economic health is less uncertain than many might be led to believe. Take, for instance, the slump in new loans and the government's move in recent months to lower interest rates.

Generally, a drop in loans and sudden interest rate cuts are omens of financial instability which indicate that businesses are losing their incentives to borrow and invest. Such logic makes sense in mature economies with developed capital markets; but in China, the situation is different.

In China, interest rates are government-capped and banks are only allowed to float their loan rates within a narrow band around a benchmark. This keeps rates on bank loans below what the current market calls for as the global economy heads toward recession. Essentially, banks have become less willing to extend credit, especially to small enterprises, when they are unable to adjust their interest rates in order to safely price risk. Thus, new loans have dried up not because of a lack of demand. Actually, many Chinese companies, especially small and medium-sized firms, desperately need credit - and it is their demand which has led to a boom in underground lending activity in Wenzhou and other entrepreneurial hubs.

Similarly, I don't think the recent interest rate cuts in June and early July point to weak credit demand, as these cuts are likely not meant to encourage more business loans. For one thing, lower lending rates wouldn't push up credit volume, but instead make banks less motivated to lend. Furthermore, if the government did want to ease monetary policy, it would probably choose to lower banks' reserve requirement ratios instead.

The interest rate reduction announced on July 5 is probably intended to ease non-performing loan (NPL) burdens for commercial banks. After years of drawing easy credit, companies and local governments are now seeing their loans come due. Unfortunately, many of them may find it hard to repay these loans as the domestic and global economies slow. Lowering their interest expenses can, to some extent, reduce their repayment burdens and deter them from defaulting on their loans.

The road to future growth will be rocky for China, but there is more to the picture than recent statistics might indicate. Yet, it would truly bring disaster to the country if the government became blinded by these figures and rushed into another round of monetary easing without careful reflection.

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