China May Join Zero Interest Rate Club As GDP Is Slowing To 4% To 5%, Oxford Economics Says

China, the world’s second-largest economy, could be the next country to join the zero interest rate club, according to Oxford Economics.

“There is a risk that Chinese short-term rates will approach the zero ‘lower bound’ by 2016,” said Adam Slater, an economist at Oxford, in a research note on Tuesday.

Oxford’s Slater believes that China’s economic growth, or gross domestic product (GDP), is actually running at a pace closer to 4 to 5 percent, well below Beijing’s official estimate of “about 7 percent” growth.

Chart courtesy of Oxford Economics

Oxford is not alone in this view as Capital Economics has also reached a similar verdict with their own tracking systems.

In June we reported that Capital Economics believed that China’s GDP growth was being overstated by 1 to 2 percentage points due to a glitch in the way it is being calculated.

The basis of the analysis by Capital Economics is focused on the “GDP deflator”, which is the inflation measure that is used to convert estimates of nominal GDP into real, inflation-adjusted terms.

According to the estimates from Capital Economics, China’s economy had only grown by 5 to 6 percent in the 12 months to the first quarter (Q1) of 2015, however Capital Economic’s says that the lower rate was closer to their own estimate — based on activity data — of 4.9 percent.

Chart courtesy of Capital Economics

But wait, China’s GDP growth could be even worse than what Oxford and Capital Economics are estimating: Lombard Street Research believes that China’s true economic growth rate is 3.8 percent and The Conference Board is estimating 4 percent growth.

Slater says that despite a raft of monetary policy measures adopted by China since late 2014, there has been only a “moderate impact,” and monetary conditions are still tight in large part due to its strengthening currency.

Broad money and credit growth have declined considerably over the last year and have at best shown tentative signs of improvement in recent months, Slater says. Meanwhile, real short-term rates have edged lower, at least as measured using the CPI.  However these developments are not nearly enough to offset an almost 15 percent real effective appreciation of the currency since mid-2014.

Slater estimates that a currency depreciation of 10 to 15 percent would be needed in order to return monetary conditions to those from 6 to 12 months ago.

But this seems to be “off the agenda” due to “prestige consideration” as well as concerns about financial stability, he said.

Slater says that as underlying GDP growth in China is still looking weak, more monetary policy moves are likely, however even zero rates may not be enough to spark the economy, and other policy action such as monetary-financed deficit spending might be needed.

In China, real short-term interest rates, as measured by the prime loan rate deflated by the CPI, have eased to around 3.7 percent from 4.5 percent late last year.