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Chinese central bank: Weak economy, ongoing economic problems

Photo: Andy Wong / dpa

The Chinese real estate industry has been in a serious crisis for a long time. The country's central bank has now countered this with an unexpectedly sharp cut in the key interest rate for mortgages.

The central bank cut the five-year reference rate – the so-called loan prime rate (LPR) – by a quarter of a percentage point to 3.95 percent. This special adjusting screw has not been loosened this much since it was introduced in 2019. Experts were surprised: “That’s the biggest signal. In other words, the largest interest rate cutting cycle in history has begun,” said analyst Yan Yuejin of the E-House China Research and Development Institution.

The 25 basis point cut will have a direct impact on the real estate sector by reducing mortgage costs. Nevertheless, the interest rate cut fizzled out on the stock markets in the Far East.

Investors apparently do not consider the step to be sufficient to significantly improve the prospects for the ailing real estate market and the overall economy. "Markets are still looking for further fiscal support measures, particularly targeting consumption," said Christopher Wong, foreign exchange strategist at OCBC.

Nevertheless, it is a step in the right direction. "This is a significant interest rate cut that shows that the political decision-makers are serious."

The real estate crisis is weighing on the economy

However, the central bank left the one-year LPR unchanged at 3.45 percent. Most new and outstanding loans in China are based on the one-year LPR, while the five-year interest rate controls mortgage pricing.

The LPR is usually granted to banks' best customers. It is set monthly after 20 designated commercial banks submit their interest rate proposals to the central bank. Since the end of the Corona containment measures at the end of 2022, the People's Republic has had problems returning to the strong economy of before the pandemic.

Prices for new buildings recorded the sharpest decline in nine years in 2023. Many real estate companies have been struggling with high levels of debt for a long time. They have overextended themselves financially in order to grow quickly. Now some of them are no longer able to complete their projects. Evergrande alone, the country's largest developer, has accumulated debts of over $300 billion.

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In addition, many regional governments that have invested large sums in expanding the infrastructure in the Middle Kingdom are massively in debt. At the same time, private consumption remains subdued. In order to support the economy, the central bank recently reduced the reserve ratio for commercial banks (RRR).

China's government in a quandary

The situation is a dilemma for Beijing. On the one hand, real estate companies should not be given carte blanche for ever higher levels of debt.

At the same time, the government is also keen to cushion an overly abrupt downturn in the real estate sector in order to mitigate the impact on the already weakening economy. Banks were recently allowed to continue supporting selected real estate companies. In addition, many cities have relaxed existing restrictions on property acquisition.

New insights into the course of the second largest economy are expected when the People's Congress begins in Beijing on March 5th. Then the government will, among other things, present the growth target and other economic goals for the current year.