Rate cut to lower borrowing cost, credit growth still on slow lane

We have been calling for a cumulative 75 basis-point lending rate cut by end 2015 and believe that the latest announcement marks an important step toward an effective lowering of real borrowing costs in China's economy. For a while now, the central bank has been adopting various "targeted easing" measures to replenish interbank liquidity and lower money market rate and bond yields. However, these measures have had little impact on banks' lending rates, which are still largely priced off benchmark rates. As a result, real lending rates have remained high and increased again recently. A benchmark lending rate cut is the most direct and effective way to lower corporate borrowing costs.

The rate cut will help loosen the tightness of financial conditions but does not necessarily imply a reversal of the central bank's monetary and credit policy stance. The central bank has adopted a less hawkish stance since the beginning of this year but the measures so far have done little to lower lending rates. The main effect of the rate cut will be to reduce the debt servicing burden and improve corporate cash flow and balance sheets, which should help to slow the pace of sour loan formation and reduce overall financial risk. It will have limited impact on corporate credit demand, which has been depressed by excess capacity and weak domestic demand, while credit supply has been controlled more by quantitative and prudential tools, which are only relaxed at the margin. We continue to expect credit growth to slow in the coming year.

The biggest near term beneficiary group will be mortgage borrowers, as mortgage rates will be reduced alongside the benchmark lending rate, helping to support property demand. Although the asymmetric nature of the rate cut will hurt banks' net interest margin, to the extent that the cut will help strengthen borrowers' balance sheets and slow the pace of sour loan formation, it should also benefit the banks.

We think further rate cuts are likely in 2015, and that their timing of delivery will be data dependent. We now think the benchmark lending rate may be cut by a further 40-50 basis points by the end of next year.

As the rate cut is within our expectation, we maintain our 2015 GDP forecast of 6.8 percent and still see risk balanced more on the downside.