Economist warn of entailing risk after rate cuts

China's recent interest rate cuts may entail risk in the property sector, and be ineffective in realizing the original intention: reducing the cost of financing.

China should be aware of home price rises brought by the rate cuts, said Yi Xianrong of the Chinese Academy of Social Sciences.

The People's Bank of China (PBOC), China's central bank cut rates almost two weeks ago for the first time in more than two years. The declared intention was the lowering of market interest rates and private financing costs.

Yi sees things differently. He argues that the cuts did not help firms raise funds but rather revitalized the comatose real estate market and delivered a sharp kick to the slumbering stock market.

From Nov. 24 to 30, immediately after the cuts, some 2,360 apartments were traded in Beijing, up 54 percent week-on-week and with the average price increasing by 10 percent.

Yi worries that if prices rise rampantly it may lead to a bubble and financial crisis.

The property sector boom began ten years ago due to open policies, loose monetary circumstance and growing demand. Its seemingly uncontrolled growth followed by acute softening is a cause for concern.

EFFECT IN DOUBT

Apart from the housing sector, the cuts had a rapid effect on shares. The benchmark Shanghai Composite Index immediately jumped over 15 percent with a huge turnover.

The rising home and share prices suggest that capital is not finding its way into the real economy. Small firms badly need money to weather the winter, and it may already be too late for some. The expected impact on financing costs remains unseen.

Yi points out that the money market even tightened after the rate cuts. The seven-day Shanghai Interbank Offered Rate (Shibor), a key barometer of interbank lending cost in China, even climbed 18.4 basis points the next day.

The central bank also raised the deposit rate ceiling to 120 percent of benchmark, purportedly to help commercial banks attract savers but also to make it more expensive for banks to absorb deposits.

The banks, themselves facing rising costs in raising money, will be more reluctant to lend at lower interest rates, Yi suggested.

In addition, the asymmetric cuts of deposit and lending rates squeezed banks' profit margins, also likely to decrease their inclination to lend.

Du Jing, economist with the Bank of Communications Schroder Fund Management, believed the cuts benefit giant state-owned companies, always favored by lenders, but will actually raise cost for small firms.

Small companies have difficulty raising money as Chinese banks are cautious and highly risk averse.

The central bank has said tackling high financing burdens is especially important in stabilizing growth and creating jobs, and the government has failed to solve the problem despite a string of measures.