On Friday, the People’s Bank of China took several major steps to stimulate that country’s economy after it slowed to its lowest level since the 2008 global financial crisis.

The bank:

  • Cut its benchmark interest rates by a quarter-point in, for the sixth time, to 4.35 percent.
  • Reduced banks’ reserve-requirement ratios, by a half of a percentage point, for the fourth time since November.
  • Removed the cap on interest rates that banks can pay for deposits.

According to a senior official at the bank, “Taking such a rare action again means the real economy is performing poorly. A lot of companies have seen their profitability falling sharply, and that’s a key reason why we took the action again today.”

Lifting the ceiling on deposits will raise the income that everyday households earn on their savings. Raising income will help China’s efforts to become an economy driven by consumption rather than exports.

But the bank’s actions might not be enough, according to Eswar Prasad, former head of the China division of the International Monetary Fund. “More drastic measures might be required in the coming months.”

Other saw reasons for hope. Aaron Kohli, interest-rate strategist at BMO Capital Markets, wrote in response to China’s action that it “reduces the probability of some of the more dire predictions about a slowdown in the world’s second-largest economy.”

Liberalizing its economy

Removing the cap on interest rates is part of a greater effort to liberalize the Chinese banking system and make it more efficient. The government wants to funnel money away from heavily indebted state-owned enterprises. Instead, People’s Bank of China wants to encourage more lending to small and private businesses, the most dynamic part of the Chinese economy.

The downside is that extra loans could foster more construction of apartment buildings and shopping malls, escalating the country’s real estate glut.

Related developments

Economists question integrity of Chinese data. In another alarming warning signal, economists outside China discount Chinese growth claims because other data releases indicated a lower growth rate than its claimed 6.9 percent.

Global emphasis on monetary policy. Chinese reliance on monetary policy to stimulate growth is part of a global trend. China’s move came one day after Mario Draghi, the chief of the European Central Bank, indicated that he would take more steps to stimulate growth and spur inflation. Earlier this year, the Bank of Japan purchased bonds to spur growth.

High likelihood of further devaluation. China’s currency slumped after Friday’s moves, reaching 6.3 yuan to the dollar. Traders are betting China will devalue the yuan further against the dollar to promote exports.

IMF board will vote next month on possible yuan reserve-currency status. The loosening of controls on deposits is a giant step by China toward getting the International Monetary Fund to include the yuan in its elite basket of reserve currencies. President Xi Jinping is eager for the yuan to enjoy the same reserve-currency status as the dollar, the euro, the British pound and the Japanese yen.

Easy monetary policies lift global spirits. Investors cheered the prospect of easy-money policies by the world’s central banks. After the announcements by Draghi and the People’s Bank, U.S. stocks rallied, lifting the S&P 500 into positive territory for the year.

Conclusion

The Chinese move is welcome news because the country accounts for almost 11.3 percent of the global economy.

Despite its slowdown, China’s growth is more than double that of other developed countries. For China to continue to grow, it needs to encourage more spending by its consumers. Currently, consumer spending is only 36 percent of its economic output. In comparison, consumer spending represents close to 70 percent of U.S. economy.

China cannot rely on exports to boost growth. Instead, it needs to stimulate the massive potential of its consumer sector.

Originally published in the Sarasota Herald-Tribune