China Cuts Rates as U.S. Turmoil Adds to Global Risks

By Li Yanping and Kevin Hamlin

Sept. 15 (Bloomberg) -- China cut interest rates for the first time in six years and allowed most banks to set aside smaller reserves as worsening credit-market turmoil and weakening export demand dimmed the outlook for economic growth.

The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent, effective tomorrow, and lowered the reserve ratio at the nation's smaller banks by 1 percentage point. The changes were in a statement on the central bank's Web site today.

Lehman Brothers Holdings Inc. filed for bankruptcy today and Merrill Lynch & Co. agreed to be sold, adding to evidence that the credit crisis is deepening and threatening the global economy. The slowest inflation in 14 months has given China room to cut borrowing costs and protect jobs in the world's fourth- largest economy.

``Policy makers see the probability of a recession in the U.S. is higher now, so the outlook for Chinese exports has deteriorated,'' said Darius Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. ``This is the beginning of an easing cycle in China.'' He was the only one of seven economists in a Bloomberg survey last week to predict a rate cut this year or in the first quarter of 2009.

The announcement came on a holiday, with markets closed.

`Important Problems'

The rate cut is ``to help solve important problems in our economy for its continued stable and fast development,'' the central bank said.

Inflation cooled to 4.9 percent in August, export growth slowed and industrial production expanded by the least in six years, according to data released last week. China's economy expanded 10.1 percent in the three months to June 30 from a year earlier, the fourth straight quarter of slower growth.

In the U.S., banks including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. formed a $70 billion fund to ensure market liquidity as Lehman filed for bankruptcy and Bank of America Corp. agreed to acquire Merrill.

The Federal Reserve has widened the collateral it accepts for loans to securities firms and boosted its program for lending Treasuries to bond dealers. It may reduce the benchmark interest rate tomorrow to 1.75 percent from 2 percent, according to the futures market.

Reserve Requirements

China's central bank pushed the reserve requirement for lenders to a record 17.5 percent in June. The biggest banks are excluded from the reduction. Those exempted are: Bank of China Ltd., Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank Corp., Bank of Communications Co. and Postal Savings Bank of China.

The requirement for smaller banks drops by 1 percentage point from Sept. 25. In areas affected by the Sichuan earthquake, the reduction is 2 percentage points.

The central bank left the key deposit rate unchanged at 4.14 percent, narrowing banks' margins on loans.

Economists were split on whether the rate cut would cause the yuan to rise or fall. Mark Williams, of Capital Economics Ltd. in London, said ``using interest rates to stimulate growth is pretty good for further yuan appreciation.''

Falling interest rates are ``obviously negative for the yuan,'' said CFC Seymour's Kowalczyk.

The currency has climbed 6.8 percent against the dollar this year, the best performer among Asian currencies. It closed at 6.8450 against the U.S. currency in Shanghai on Sept. 12.

Stock-Market Slump

Zhu Baoliang, the chief economist at the State Information Center, a government research agency, said August's weaker economic data probably prompted today's moves, rather than events in the U.S.

Capital Economics' Williams said it was ``suspicious'' that the central bank acted when the Shanghai Composite Index seemed set to drop below 2,000. It closed on Sept. 12 at 2,079.67 after slumping 60 percent this year on concern that measures to tame inflation will erode company profits.

The property market could be headed for a ``meltdown'' as home prices and sales decline, Morgan Stanley said Sept. 12.

China's policy makers have already loosened loan quotas -- restrictions on how much banks can lend -- and raised export-tax rebates for garments and textiles to help exporters and small businesses.

-- With reporting by Chua Kong Ho in Shanghai and Patricia Kuo in Hong Kong. Editors: Paul Panckhurst, Riad Hamade.

To contact the reporters on this story: Li Yanping in Beijing at yli16@bloomberg.netKevin Hamlin in Beijing on khamlin@bloomberg.net