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China's central bank acted decisively on Monday to prop up the country's slowing economy by cutting the cost of bank loans for the first time since February 2002. Against a background of acute stress in global financial markets, the People's Bank of China also lowered the reserve requirement for all banks, except the five largest and the Postal Savings Bank, by 1 percentage point.
Both cuts were unexpected. It is the first time that the central bank has lowered the proportion of deposits that lenders must hold in reserve since November 1999. "We all knew that there would be monetary policy relaxation in China, but we didn't expect the move would be so quick," said Gao Huiqing, an economist with the State Information Centre, a government think-tank in Beijing.
The 0.27 percentage point cut in benchmark lending rates lowers the cost of one-year bank loans to 7.20 percent from Tuesday, the PBOC said on its website, www.pbc.gov.cn. China adjusts interest rates in increments that are divisible by nine because it makes interest calculations easier for lenders, which work off a 360-day banking year.
With inflation still uncomfortably high, the central bank kept benchmark savings rates unchanged at 4.14 percent for one-year certificates of deposit, pointing to narrower lending margins for the vast majority of banks. Gao Linzhi, a strategist at Great Wall Securities in Shenzhen, said the measures should help to put a floor under the Shanghai stock exchange's main index at 2,000 points.
The index, which closed on Friday at 2,079.67, has lost 65 percent since hitting a record high last October. The market was closed on Monday for a public holiday. "This is obviously bad for the banking sector because of the shrinking interest rate spread, but it's good for the real estate sector and other industries which depend heavily on borrowing," he said.
The abrupt easing of policy came shortly after US investment bank Lehman Brothers filed for bankruptcy and Merrill Lynch agreed to be bought by Bank of America. But a reference to the global credit crisis was conspicuous by its absence in the PBOC's statement.
Instead, the central bank said it was acting to "maintain the stable, fast and continuous development of the national economy", the world's fourth-largest. "It shows that the Chinese leadership has a very clear idea of where the economy is heading - China's economy is moving into a period of adjustment," said Gao at the State Information Centre.

Copyright Reuters, 2008

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