[Why&Next] Lowered Base Rate and Met the US... But the China-Generated Tailwind Has Not Arrived Yet

PBOC Cuts Benchmark Interest Rate to Boost Economy
Expected to Help South Korean Exports Highly Dependent on China
However, Doubts Over China's Recovery Amid 'Liquidity Trap'
Ultimately, US-China Conflict Remains Key... Watch for Additional Stimulus Measures

As China lowered its benchmark interest rate for the first time in 10 months and a meeting between Chinese President Xi Jinping and U.S. Secretary of State Antony Blinken, the fourth-ranking official in the U.S., was arranged, expectations for an economic recovery originating from China are gradually reviving. Although the ripple effects of China's reopening (resumption of economic activities) in the first half of the year were less than expected, if Chinese authorities demonstrate a strong commitment to economic stimulus, South Korean exports could rebound, strengthening the 'low in the first half, high in the second half' trend as forecasted by the Bank of Korea and the government.

However, many analyses suggest it is still too early to expect a favorable wind from China. Although China made a sudden cut to its benchmark interest rate, the structural slowdown in domestic demand in China is unlikely to recover quickly, and U.S. sanctions against China have not yet been resolved. Especially amid significant concerns over various debt risks, it is also considered difficult for Chinese authorities to introduce innovative economic stimulus measures in the near future.

People's Bank of China Cuts Interest Rate... "Helps Korean Exports"

The People's Bank of China, the country's central bank, lowered the 1-year and 5-year Loan Prime Rates (LPR), which effectively serve as benchmark interest rates, by 0.1 percentage points yesterday. The 1-year LPR was cut for the first time in 10 months since August last year. Since China lowered the 1-year Medium-term Lending Facility (MLF) rate, considered a gauge of the benchmark rate, by 0.1 percentage points last week, this LPR cut was anticipated. However, the market is focusing on linking this move to the authorities' willingness to stimulate the economy.

Typically, a rate cut in China is good news for the South Korean economy. According to an analysis by the Bank of Korea at the end of 2021 on the impact of China's monetary policy on Korea, when China adopts a more accommodative monetary policy, South Korea's exports to China, especially intermediate goods, increase significantly. When China's interest rate cut leads to a depreciation of the yuan, Chinese products become more price competitive, increasing exports to advanced countries, which in turn boosts South Korea's exports as it sends many intermediate goods to China.

Even aside from this flow, a rate cut signals China's intention to stimulate the economy, which is positive for South Korea, highly dependent on China. Over the past 10 months, the rapid increase in U.S. benchmark interest rates limited China's ability to cut rates, but the Federal Reserve's rate pause last month has somewhat eased the People's Bank of China's constraints. If the Fed signals the end of its tightening cycle after July, expectations are rising that China will accelerate monetary easing.

China Trapped in 'Liquidity Trap'... Doubts on Economic Recovery

However, many believe that China's accommodative monetary policy and gestures of reconciliation with the U.S. alone are insufficient to expect an economic upswing from China. While the LPR cut reflects China's intentions, it is difficult to produce effects that can immediately change the domestic atmosphere. Voices are emerging even within China that despite the authorities' rate cuts, corporate investment and household consumption are not increasing, indicating that monetary policy effectiveness is constrained by a 'liquidity trap.'

Professor Kang Sung-jin of Korea University’s Department of Economics said, "China is not a country that moves based on interest rates, so I believe the effect of this rate cut will not be significant. The ongoing relocation of multinational companies out of China due to U.S.-China conflicts means that the situation will improve only when relations between the U.S. and China improve and trade normalizes."

The Wall Street Journal (WSJ) reported on the 13th (local time) regarding the People's Bank of China's willingness to stimulate the economy: "According to economists, Chinese households and companies, already burdened with high debt levels and bleak growth prospects, show little appetite for borrowing, so low borrowing costs may do little to aid China's weak recovery."

This is also linked to the possibility of deflation in China. Although China has grown its economy through massive fiscal spending, the central government is now pursuing 'deleveraging' (debt reduction), making it difficult to increase consumption and investment as in the past. According to a recent International Monetary Fund (IMF) report, the total debt of Chinese local governments amounts to about 66 trillion yuan (approximately 1,179 trillion won), and global banks estimate that including hidden debts, the total debt could be twice that amount.

WSJ pointed out, "Due to the pressured global environment for exports, consumers are reluctant to increase spending, and (China's economy) is losing momentum in recovery," adding, "Last week's low inflation figures showed that China is at risk of experiencing deflation, a decline in prices." Consequently, despite the massive debt, voices within China are growing, especially among Chinese officials, calling for "stronger policies to prevent the economy from entering a downturn phase."

Heightened Attention on Additional Stimulus in China... Diverging Forecasts

Experts believe that the extent of stimulus measures that Chinese authorities will introduce in the short term will significantly impact South Korea's economy in the second half of the year. Earlier, the State Council of China held a meeting chaired by Premier Li Qiang on the 16th, stating that "more effective measures must be taken to promote sustained economic recovery," implying forthcoming policy actions. However, forecasts still differ regarding the timing and intensity.

Researcher Baek Eun-bi of Eugene Investment & Securities explained, "The stimulus package that the State Council is preparing is unlikely to be strong," but added, "Support for existing areas such as consumption promotion, corporate cost reduction, advanced industry support, and special bond issuance is expected to be strengthened." On the other hand, Jeon Jong-gyu, a researcher at Samsung Securities, predicted, "Due to the issuance of 1 trillion yuan in special bonds to activate infrastructure investment, the infrastructure investment growth rate this year will exceed 8%."

Professor Kang Sung-jin expressed the view that it might be difficult for Chinese authorities to implement aggressive stimulus measures, saying, "South Korea also faced many concerns in the 1980s about the country collapsing due to external debt, and even now household and corporate debts are high. China is similar. Although there are talks about China falling into the middle-income trap, if China can continue its growth, it can cover potential bad debts. Ultimately, it depends on President Xi Jinping."

This content was produced with the assistance of AI translation services.