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China's economic challenges and desperate measures: A closer look

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2023-08-21

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On Friday, the People's Bank of China (PBOC) set a significantly stronger daily fixing for the yuan, causing the currency to recover from the 9-month low it hit on Thursday. However, the yuan later weakened against the dollar to 7.3060 in offshore trading, following the PBOC's official mid-point of 7.2006, which was more than 1,000 points higher than market estimates.

This intervention highlighted the severity of China's economic outlook. There was an air of desperation in the move, occurring just three days after the central bank lowered a key interest rate, injected $US104 billion into the money markets, and announced a more substantial rate cut for the near future.

This effort to bolster the yuan reflects mounting concerns within the Chinese government about the currency's decline and the negative message it conveys to the global community. The government, led by President Xi Jinping, appears to be losing control of the economy's trajectory, and foreign investors are capitalising on this situation.

With China Evergrande's bankruptcy and Country Garden's debt uncertainties putting the spotlight on the struggling property sector, all eyes are on the Loan Prime Rate (LPR). The LPR, China's most significant rate, is expected to be cut for the second time in three months. This cut is not primarily due to the property sector's troubles, but rather because the People's Bank of China (PBOC) reduced the rate on the one-year medium-term lending facility (MLF) last week and injected a significant amount of yuan into the money markets to ensure liquidity.

The recent cut to the MLF rate, down to 2.5% from 2.65% (already down from 2.75% in June), is anticipated to be passed on to the Loan Prime Rate, potentially reducing it from 3.55% to 3.4%. Yet, the cuts implemented in June had minimal impact, and the anticipated cut in the Prime Loan Rate (PLR) is unlikely to yield significant results unless it's substantial enough to shock investors.

Since the rate cuts in June and reductions in Reserve Ratios for banks in March, China's economy has slowed, inflation has turned to deflation, exports and imports have both declined, and unemployment has slightly risen.

The AMP's chief economist, Shane Oliver, noted, "More policy stimulus measures are likely so it would be wrong to get too negative on China, but with the Government seemingly worried about adding to debt it risks remaining too constrained."

Despite efforts to attract foreign investment and boost market confidence, the disconnect between officials calling for investment and a sweeping national security crackdown is causing a dent in business confidence. The situation presents a complex challenge for China as it navigates its economic course.

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