China Cuts Rate to Protect Economy That's Now `Big Enchilada'

By Kevin Hamlin

Oct. 9 (Bloomberg) -- Wednesday may go down as the day the economic balance of power shifted in Asia.

In a move weighted with symbolism, China reduced its interest rate within minutes of cuts by the U.S. Federal Reserve and five other central banks, while Japan, the world's second-biggest economy, stayed on the sidelines.

``Japan is still a very big economic power, but China is the big enchilada on the field,'' said James Lilley, a former U.S. ambassador to Beijing. ``They really, in their own way, are joining the world financial community in dealing with a very severe crisis.''

China's move reflects how deeply the world's fourth-biggest economy has become integrated in the global financial system. While its gross domestic product expanded at 10.1 percent in the second quarter from a year earlier, its exports have been hit by a collapse in demand from the U.S. and Europe.

That contrasts with the situation in Japan, which was a founding member of the then-Group of Six national leaders who first met in Rambouillet, France, in 1975. China at the time was still led by Mao Zedong, who imposed the Cultural Revolution on his poverty-ridden nation.

The Bank of Japan said it abstained from the rate cut yesterday because its 0.5 percent lending rate was already ``very low'' -- at a time when the economy is contracting. The central bank expressed support for the coordinated cuts.

No Mention

The People's Bank of China pared its one-year lending and deposit rates by 0.27 percentage point to 6.93 percent and 3.87 percent, according to a statement released on its Web site that didn't mention the coordinated effort by the Fed, the European Central Bank or the others.

China's reduction shows increased anxiety about the impact of the credit crisis on its own economy. The CSI 300 Index of stocks fell 3.8 percent yesterday for a 62 percent slump this year.

Premier Wen Jiabao said on Sept. 27 that his nation wants to participate in a global solution.

``All countries should take proactive measures'' to deal with the financial crisis, and prevent it from spreading, he said in a televised speech to a conference.

``We share the same interest and goal in facing this crisis,'' the People's Bank of China said a week later, after the U.S. approved a $700 billion rescue plan for its financial system. ``All countries should take the responsibility to cooperate.''


Currency, Quotas

It was the second rate reduction from China in a month, and comes on top of measures already taken to mitigate the effects of slowing exports.

The central bank has eased quotas that limit how much money banks can lend, slowed the appreciation of the yuan against the dollar to protect jobs and raised export-tax rebates for garments and textiles.

``China's participation in this seemingly coordinated rate cut is encouraging given its importance to the global economy,'' said Jing Ulrich, chairwoman of China equities at JPMorgan Chase & Co. in Hong Kong. ``China is becoming more responsible as an involved stakeholder.''

Japan and China are the two largest foreign creditors of the U.S.: Japan holds $593 billion of U.S. Treasury bills, followed by China with $519 billion.

``China owns us, lock, stock and barrel, so it's more important than ever that the U.S. monetary authorities coordinate their monetary policies with China,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York.

Panic Selling?

Former central bank adviser Yu Yongding said in a Sept. 23 interview that the country is worried about panic selling that could lead to a collapse of the global financial system.

China's huge holdings of U.S. debt means it must bear a large proportion of the ``burden of sorting things out'' in the U.S., Yu said. ``China is very worried about the safety of its assets.''

``If Japan were to have followed suit, it would have had to drop it down to zero, and they don't want a zero interest rate policy,'' said Ross Schaap, an Asia analyst at the Eurasia Group in New York. Julian Jessop, an economist at London-based Capital Economics, said low rates could actually hurt growth by reducing incomes of the country's high-savings households.

Japan's government was left seeking a response as the benchmark Nikkei 225 Stock Average yesterday plummeted 9.4 percent, the third-largest decline on record. The yen climbed below 100 to the dollar for the first since April.

Not Normal

``This isn't normal,'' Taro Aso, who became Prime Minister last month, told parliament. Such a collapse in stock prices ``is frankly beyond our imagination,'' he said.

Japan's lower house approved a three-month-old stimulus package drafted by Aso's predecessor that the government acknowledges is inadequate.

BOJ Governor Masaaki Shirakawa indicated even before yesterday's coordinated cuts that Japan would go its own way on interest rates.

``It's appropriate for each nation to make a judgment based on its own economy and prices,'' Shirakawa told reporters. Any coordinated action that doesn't reflect this would be ``undesirable,'' he said.

The Bank of Japan has been adding yen to the money market and began to offer dollars under a swap agreement with the Fed last month.

``Shirakawa signaled that Japan would march to its own monetary tune,'' said John Richards, head of debt strategy for the Asia-Pacific region at RBS Securities Japan Ltd. in Tokyo.

To contact the reporter on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net