Chinese Government Takes Action... Cuts Benchmark Interest Rate and Adjusts Local Debt

1-Year LPR Rate Cut by 0.1% Point
Local Criticism of Regional Debt Measures as 'One-Time' Solution

As concerns over a slowdown in the Chinese economy intensify, Chinese financial authorities have launched an all-out response. Following a cut in the prime loan rate (LPR), which effectively serves as the benchmark interest rate, for the first time in two months, they have decided to issue refinancing bonds to ease pressure from local government debt, considered a key economic risk. However, they showed a somewhat cautious stance regarding the extent of the rate cut and the reduction of real estate loan-linked rates.

On the 21st, the People's Bank of China, the country's central bank, adjusted the 1-year LPR down by 0.1 percentage points to 3.45%. The 5-year LPR remained unchanged at 4.20%. The LPR is calculated by aggregating the loan rates offered to top-tier clients by 18 designated banks. Local financial institutions use this as a benchmark to set their loan rates, making it a practical benchmark interest rate. The 1-year rate affects general loans, while the 5-year rate influences mortgage loans.

This is the first cut in the 1-year LPR since June (a 0.1 percentage point reduction). In July, both the 1-year and 5-year rates were held steady. The market had expected the People's Bank of China to lower both the 1-year and 5-year rates by 0.15 percentage points on this day.

This rate cut came shortly after the People's Bank of China injected 297 billion yuan (approximately 51 trillion won) into the market through a 7-day reverse repurchase agreement (reverse repo) and lowered the policy rate for the 1-year Medium-term Lending Facility (MLF) loan from 2.65% to 2.50%, a 0.15 percentage point cut. This move is analyzed as an effort to supply liquidity in response to the recent sluggish economic atmosphere in China. In July, China's retail sales and industrial production increased by 2.5% and 2.7% year-on-year, respectively, falling short of market expectations.

However, monetary authorities appear to have taken a conservative stance on supplying liquidity to the real estate market while lowering rates linked to general loans to stimulate domestic demand. Despite the domino risk of defaults among real estate-related companies such as Hengda, Biguiyuan, and Zhongrong International Trust, the Chinese government has shown reluctance to actively intervene in rescues.

Alongside this, Chinese authorities have decided to allow the issuance of special refinancing bonds worth 1.5 trillion yuan to alleviate the local government debt crisis, considered a key risk to the Chinese economy. According to Chinese economic media Caixin, a package plan to reduce local debt was discussed at the Politburo meeting held last month.

This plan involves participation from the People's Bank of China and other financial institutions. The goal is to ease hidden debt pressures. The bonds are expected to be issued in 12 provinces and regions with high debt pressure, including Tianjin, Guizhou, Yunnan, Shanxi, and Chongqing.

Caixin also reported that the People's Bank of China is considering establishing special purpose companies (SPCs) with commercial banks to provide long-term liquidity to local governments at low cost. If implemented, this measure is expected to somewhat ease liquidity pressures on Local Government Financing Vehicles (LGFVs). As the downturn in China's real estate market prolongs, local governments, which relied on real estate revenues, face fiscal crises, and the soundness of LGFVs has rapidly deteriorated.

According to Wang Tao, UBS's Chief China Economist, local government debt not exposed externally, including contingent liabilities, is estimated to have reached 42.7 trillion yuan as of the end of last year. Local credit rating agency Chengxin International estimates the related scale to be between 52 trillion and 58 trillion yuan.

However, there are calls in the market for more fundamental measures. Bond analyst Xian Binbin of Tianfeng Securities explained, "Regulators need to optimize debt conditions and interest rates based on market mechanisms and the rule of law." Luo Zhiheng, Chief Economist at Yuekai Securities, also emphasized, "In the short term, the refinancing issue must be addressed, but this is still a relief measure, and problems will arise again someday," adding, "To solve the debt problem, the scale and boundaries of government functions must be fundamentally addressed."

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