The benchmark lending rate will be lowered by 0.27 percentage point to 7.20 percent from Tuesday, but the interest rate of deposits remains unchanged.

The 1 percentage point cut from the reserve requirement ratio of 17.5 percent does not apply to the five biggest banks and the Postal Savings Bank, the People's Bank of China (PBOC) said on its website. And banks in areas hit by the devastating May 12 earthquake will have their ratio cut by 2 percentage points. These changes will come into effect from Sept. 25.

"The adjustment is directly related to the macro-economic data for August," said Zhang Jun, director of Fudan University's China Center for Economic Studies.

The figures for the economy in August, released last week, showed a drop in consumer inflation but a rise in factory gate cost (or producers price index, PPI), a weakening industrial output and falling imports. All these indicate "downside economic risks", Zhang said.

The rising PPI and falling consumer price index (CPI) rate mean corporate earnings would suffer as costs rise, and that would ultimately hurt economic growth, Liu Dongliang, economist with the China Merchants Bank, said. "The country is facing the danger of an economic downturn."

The government adopted tightening measures in the second half of last year to prevent the economy from overheating and keep the CPI from rising out of control.

It has raised the interest rate six times and the reserve requirement ratio 15 times since last year, with the latest ratio increase being the fifth this year.

The tightening measures have yielded results, but the change seems to have come much sooner than expected, prompting the authorities to ease the policies, Zhang said.

The country's GDP for the second quarter grew 10.1 percent year-on-year, compared to 11.9 percent for the whole of 2007.

The situation is similar to what it was 10 years ago, when the macro-economic regulation before 1997 coupled with the 1997-98 Asian financial crisis, hit the economy hard and pushed it into deflation, he said.

Now the economy faces a slowdown at home and is already feeling the winds of the U.S. financial turmoil.

Policymakers later adopted a series of measures, such as bolstering small and medium-sized enterprises (SMEs), to maintain a stable economic growth.

The SMEs are the most dynamic components of the economy, accounting for three-fourths of the total jobs in the country and producing 60 percent of the goods and services. And it is they that have suffered the most since last year because of the tightening policies.

Banks usually do not like sanctioning loans to SMEs because of fears they may fail to pay back in time, and the tightening policies have worsened the situation for them, analysts said.

"The key issue now is how to better allocate the lending resources to ensure SMEs have more access to loans," Zhang said. The PBOC has cut the requirement for smaller banks because most of their loans go to SMEs.

But the liquidity problem has not been fundamentally solved, he said, and the authorities have stopped short of applying the cut in reserve requirement ratio to major banks.