Tag Archives: Interest rates

China’s Interest-Rate Liberalization Takes A Sideways Step

IS THE PAST prologue when it comes to China’s interest rates? For two years, the answer was no. Late last week, that answer changed with the central bank’s surprise cut in its benchmark one-year lending rate by 40 basis points (bps) to 5.6% and the matching deposit rate by 25 bps to 2.75%, its first cuts since July 2012. More to come is the question now.

An across-the-board measure is at odds with the targeted approach to managing the economy’s slowdown hitherto pursued by the People’s Bank of China. In September, it had injected 500 billion yuan ($81 billion) of liquidity into the five big banks to support credit and growth. Earlier in the year, it had cut reserve requirements for rural commercial banks and credit cooperatives.

Nonetheless, the central bank says that its rate move does not represent a change in monetary policy. In as much as the benchmark lending rate is largely symbolic, that may be true in a perverse way. The bank also lifted the maximum permitted deposit rate to 1.2 times the benchmark from 1.1 times. That is another incremental step in the direction of interest-rate liberalization. However, it will also largely negate the effect of the newly announced rate cut on the economy.

If anything the asymmetric cut will amplify the narrowing of the gap between lending and borrowing rates that has been going on for some time. That, we think, is more likely to cool the home-building market, as it will make home-buying loans even less profitable for banks than they are now, than to stimulate it.

If the economic mood music does not seem to presage further cuts, this Bystander suspects that factional infighting is underway, with the State Council leaning on the central bank to cut corporate borrowing costs. That mostly benefits the politically well connected large state-owned enterprises, who do not particularly need to borrow money, but will be happy enough to see their profit margins expanded through lower financing costs. As we have noted before, there are still vested interests providing considerable obstacles to the drive for economic reform.

The language of the central bank’s explanation of its rate move is telling. It is casting the cut in terms of financing costs, especially for small businesses, rather than a need to stimulate a slowing economy. However, if it is serious in what it says about guiding market rates lower, it would be best served by advancing the cause of interest-rate liberalization.

In its statement explaining the cut, it says:

Market-oriented interest rate reform is a systematic task, and calls for coordination with other reforms. Therefore we need to strengthen the coordination of various reform measures, unite those together as a force, and in the end finish building the mechanism and system to fully allow for the market’s decisive role in resource allocation and better allow the government to function.

The central bank has been a leading proponent of financial reform. Those measured words sound like it is on the back foot at the moment in the broader political debate.

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China Takes Critical First Step To Liberalize Interest Rates

China’s long-awaited liberalization of its interest rates is a big deal. Initially it is a bigger deal symbolically than in reality; only the floor on the rates that banks charge for loans is being scrapped in this first move; the People’s Bank of China says it will proceed slowly with what it calls such a risky undertaking and the cap on deposit rates remains for now. A small portion of all loans will be affected immediately (only 11% of existing loans were made at a discount to the benchmark rate). But its importance lies in the fact that the first step has at last been taken in a critical leg of financial markets reform. It puts China firmly on the path to a fully convertible currency and floating exchange rates.

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China’s Rate Cut Signals Weak Q2 GDP Number

This Bystander’s first take on China’s surprise cut in interest rates, its second in barely a month, is that the second-quarter GDP number due to be released next week will be below expectations. The consensus view of private economists is that the economy grew by 7.5% between April and June, down from the first quarter’s 8.1%. That would represent a sixth consecutive quarter of slowing growth, and be the slowest quarter since the immediate aftermath of the 2008 global financial crisis.

The People’s Bank of China has cut its benchmark one-year lending rate by 31 basis points to 6% and the deposit rate by 25 basis points to 3%, both effective from Friday. Banks will also be allowed to increase the discount they can offer on their loan rates to 30% from 20%, a twin effort to stimulate more demand for credit and liberalize interest rates a tad further.

The reduction in consumer price inflation from last year’s peak leaves headroom for more monetary easing, rate cuts and reductions in banks’ capital reserve requirements should the anticipated bottoming out of the growth slowdown not occur during the second half.

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Inflation Fall Confirms Scope For Rate Cuts

The economic indicators we are expecting to provide the context for this week’s surprise quarter percentage point cut in interest rates by the People’s Bank of China are starting to come in. Among the first to arrive is consumer price inflation. At 3% for May, it is at its slowest monthly growth rate in two years, and down from April’s 3.4%, resuming the decline from last July’s 6.5% peak. The producer price index fell to 1.4% in May, confirming the global weakening of demand.

Both falls provide the headroom to cut rates without rekindling inflationary expectations. The cut in retail gasoline prices also announced this week was insurance. At least one more round of cuts to the banks’ reserve ratios followed by another modest interest rate cut seems likely for later this year.

Update: Industrial output in May ticked up by 0.3% from April’s 9.3% growth rate while fixed-asset investment, up 20.1% year-on-year, showed its third consecutive month of slowing growth and retail sales grew by 13.8%, down from April’s 14.1%. In short, plenty of evidence to support the shift of policy from reducing inflation to promoting growth. Zhuang Jian, an economist with the Asia Development Bank, summed up policymakers’ dilemma when he told state media:

Relying on investment to pull growth will have an immediate effect, but it will have negative repurcussions if not used rightly, while the consumption driver, though carries long-term value, is slow to boost economy.

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China Cuts Interest Rates As Economy Slows

This Bystander has been relatively sanguine about the pace at which China’s economy has been slowing. Thursday’s surprise announcement of the first cut in interest rates since 2008 suggests the economic headwinds are blowing harder than thought.

The benchmark one-year lending rate will fall by one quarter of a percentage point to 6.31%, and the discount banks can offer doubled to 20%, both effective Friday. At the same time the one-year deposit rate will be lowered by a matching 25 basis points to 3.25%.

The latest monthly inflation, investment and output numbers due out over the next couple of days will no doubt provide the evidence of why the cut is needed and can be made now. Even if the cut is only to hold real (i.e. inflation-adjusted) interest rates, the question is whether companies’ weak spending is because borrowing costs are too high or because they already have sufficient capacity to meet lessening demand. We suspect it is the latter.

Footnote: Wednesday’s second postponement of new bank capital adequacy rules, this time until the start of next year, a year on from their original implementation date, clears space for additional lending-driven stimulus should the government feel it needs to step in again to provide some demand.

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Chinese Bond Yields Flashing Good Market Signals

China’s bond markets are now sufficiently good leading indicators of growth and inflation that China’s central bank could switch from using quantitative targets and administrative controls to money-market interest rates to execute monetary policy, according to a new IMF Working Paper by Nuno Cassola and Nathan Porter. The two say that “while  bond yields are not fully efficient—reflecting regulation, liquidity, and segmentation—we find they contain considerable information about the state of the economy as well as evidence of an emerging transmission channel: changes in [People’s Bank of China] rates influence the structure of Treasury, financial, and corporate bond yield curves.”

Cassola and Porter, who are with the European Central Bank and International Monetary Fund respectively, also say there is strong evidence that regulated retail interest rates significantly affect bond yields, making this regulation one likely cause of pricing inefficiencies. The two say that further liberalization across bond markets (their study looked at four interbank bond markets and the retail markets for exchange-traded Treasury bonds) will strengthen both efficiency and transmission, and that necessary elements to move towards market-based monetary policy are in place.

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China’s Last Interest Rate Rise For The Year?

Have we seen the last interest rate rise for the year? A consensus is emerging among analysts that we have with the fifth raising of interest rates in eight months.

The Peoples’ Bank of China raised one-year lending rates by 25 basis points to 6.56% from Thursday, while one-year deposit rates went up by the same amount to 3.5%. The end-of-the-liners’ underlying assumption is that inflation will peak in June or July (June’s figure is due next week) and then moderate with falling food prices, letting policy makers switch their attention to the slowing of the economy, possibly heralding stimulative fiscal measures with added investment in property and infrastructure (we continue to be skeptical that those are needed; real negative interest rates, even with the latest increase, will take care of pumping property up).

While we follow the arc of the argument, we are not sure about its timing. Inflation may linger long enough for another step rise in rates to be warranted. Lingering even more menacingly in the background is also the fear that the local government debt bomb might get triggered if rates rise too far, making even more of the debt non-performing. Higher capital reserve ratios for the banks are likely to be doing the heavy lifting for monetary policy for the rest of the year.

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