China’s rate cut: di­min­ished re­turns

Financial Mirror (Cyprus) - - FRONT PAGE -

First the Bank of Ja­pan, then the Euro­pean Cen­tral Bank, and now the Peo­ple’s Bank of China. Last Fri­day, the PBOC cut its bench­mark in­ter­est rates for the first time since July 2012. The di­rec­tion of the move had long been fore­seen, but the tim­ing of the an­nounce­ment came as a sur­prise. We had ex­pected con­cerns over China’s high lev­els of do­mes­tic debt would en­able the cen­tral bank to re­sist pres­sure to cut rates un­til the first quar­ter of next year. Now that the new eas­ing cy­cle is un­der way, the key ques­tion is whether rate cuts will ig­nite a boom in credit growth ap­proach­ing the mag­ni­tude of those seen in 2009 and 2012. We be­lieve they will not. It is likely that loan de­mand will pick up from re­cent lows, but reg­u­la­tory and eco­nomic con­straints will pre­vent the run­away growth ex­pe­ri­enced in pre­vi­ous cy­cles. As a re­sult, the ef­fect on over­all GDP growth will be mod­est, with the ben­e­fits of lower rates felt mainly by the prop­erty sec­tor and, to a lesser ex­tent, state-owned in­dus­tries.

With a slow­down in pri­vate in­vest­ment weigh­ing on eco­nomic

sec­tor growth, in­fla­tion fall­ing, and tar­geted liq­uid­ity in­jec­tions fail­ing to lower lend­ing rates, China’s State Coun­cil de­manded a re­duc­tion in cor­po­rate bor­row­ing costs at its meet­ing last week. Two days later, the PBOC obliged by cut­ting in­ter­est rates. The re­duc­tion was asym­met­ric. The bench­mark one-year lend­ing rate was cut by 40bps to 5.6%, while the oneyear de­posit rate was cut only 25bps to 2.75%. At the same time, the cen­tral bank also pressed ahead with in­ter­est rate lib­er­al­i­sa­tion, al­low­ing banks to of­fer up to 20% above the bench­mark de­posit rate, which means the ceil­ing on the one-year de­posit rate is un­changed at 3.3%. The de­mand de­posit rate is also un­changed at 0.35%.

Even so, we be­lieve both bank fund­ing costs and lend­ing rates will de­cline. Some smaller banks have left their bench­mark de­posit rates un­changed at 3.3%. But most, in­clud­ing the big five state-owned banks which ac­count for 45% of to­tal de­posits, cut their one-year de­posit rates by 25-30bps to 3%. As a re­sult, av­er­age fund­ing cost in the bank­ing sys­tem will de­crease by about 20bps, giv­ing banks room to cut lend­ing rates. Although lend­ing rates are fully lib­er­alised, loans are com­monly priced us­ing the bench­mark lend­ing rate as a ref­er­ence, so ac­tual loan rates will fall in line.

With in­fla­tion sub­dued and the gov­ern­ment de­ter­mined to bring down real bor­row­ing costs, fur­ther eas­ing is on the cards. While the PBOC will con­tinue to use its new tar­geted eas­ing tools and may well re­duce re­serve re­quire­ment ra­tios, if re­cent his­tory is any guide, more rate cuts are likely.

The cru­cial ques­tion is how the new eas­ing cy­cle will af­fect credit growth and eco­nomic growth. In both 2009 and 2012-13, credit growth surged fol­low­ing rate cuts. In 2009, to­tal credit growth leaped to 36% as new bank loans dou­bled the tar­get of­fi­cial tar­get. In re­sponse, GDP growth re­bounded to 12% and prop­erty prices sky­rock­eted. In 2012-13, YoY loan growth bounced mod­estly to 16%, but to­tal credit growth re­bounded to 22% in early 2013 as shadow fi­nanc­ing ex­ploded. The credit eas­ing ig­nited another prop­erty boom, but the im­pact on the real econ­omy was limited as real GDP growth only re­cov­ered to 7.9%.

This time around the ef­fects will be even more mod­est. Although credit growth is likely to re­cover from its cur­rent level of 14%, sev­eral con­straints will hin­der a vig­or­ous re­bound. First, in past eas­ing cy­cles the strong­est de­mand for loans came from lo­cal gov­ern­ments. Now, the Min­istry of Fi­nance is cracking down on bor­row­ing by lo­cal gov­ern­ment-backed projects in an at­tempt to re­duce debt lev­els. Sec­ond, with non­per­form­ing loan ra­tios ris­ing, Chi­nese banks have be­come more cau­tious about coun­ter­party risk and are un­will­ing to lend as crazily as in the past. Third, be­cause of the strong US dol­lar, cap­i­tal in­flows have abated, lim­it­ing the scope for do­mes­tic liq­uid­ity cre­ation. Fourth, in re­cent months the PBOC and the China Bank­ing Reg­u­la­tory Com­mis­sion have con­sid­er­ably tight­ened the rules gov­ern­ing the shadow fi­nanc­ing mar­ket which, far from ex­pand­ing ex­plo­sively as in the past, is now ac­tu­ally shrink­ing.

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