China to Slash Rates, Spend to Fuel Growth, Morgan Stanley Says

By Kevin Hamlin

Oct. 7 (Bloomberg) -- China will cut interest rates as many as five times by the end of 2009 and will step up spending to limit the effect of the ``global financial tsunami'' on the nation's economic growth, Morgan Stanley said.

The central bank will cut borrowing costs by 27 basis points each time, reducing the one-year lending rate to as low as 5.85 percent next year from 7.2 percent now, Qing Wang, a Hong Kong- based economist, said in a note today. Government spending may add as much as 3 percentage points to economic growth, he said.

Global growth is slowing after the collapse and bailout of banks in the U.S. and Europe propelled the cost of borrowing in money markets to the highest ever. Slowing economic growth in Europe and the U.S., which account for 40 percent of China's total exports, will translate into lackluster exports, falling corporate profit and easing inflation, Wang said.

``A substantial improvement in the inflation outlook should help ease the lingering concerns about the inflationary consequences of an expansionary macroeconomic policy,'' Wang said. ``We expect a decisive policy shift toward boosting growth in the coming weeks and months.''

Wang cut his forecast for inflation next year to 2.5 percent from 4 percent. He lowered his estimate for economic growth in China next year to 8.2 percent from 9 percent and lowered his forecast for this year to 9.8 percent from 10 percent.

More spending and tax cuts would contribute between 1 and 3 percentage points to growth, Wang said.

China can ``afford to run multiyear fiscal deficits without running into debt sustainability problems,'' because it has public debt of only 30 percent of gross domestic product, Wang said.

Property Market Risk

The main risk to his forecast was a ``meltdown'' in the property sector across the country, ``which would lead to a massive collapse in real-estate investment, Wang said.

The consequences would be so serious that even pro-growth policies wouldn't prevent the economy growing less than 7 percent, he said.

The probability of this happening is less than 25 percent, Wang estimated, contradicting a Sept. 12 report by Jerry Lou, a Morgan Stanley strategist, who said the ``likelihood of a property sector meltdown is high.''

China thus has ample room for monetary and fiscal initiatives to help offset the impact of slower global growth, he added. This would entail ``unwinding'' tightening measures introduced since last year, including ``the 162 basis points interest rate hike, the 850 basis points hike of the required reserves ratio, and stringent administration bank lending quotas,'' he said.

The People's Bank of China cut the one-year lending rate to 7.20 percent from 7.47 percent, the first reduction in six years, last month.

Morgan Stanley forecasts that the U.S. economy will contract by 0.2 percent next year and that growth in the Europe will reach only 0.2 percent. It expects a 1 percent contraction in Japan.

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