Schroders Quickview: Chinese reforms and easing unlikely to boost growth
There were two significant announcements from China’s policymakers last week. They mark a change of stance by the People’s Bank of China (PBOC), which until now had focused on selective easing measures and liquidity injections.
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Firstly, the one year deposit rate was lowered by 25 bps to 2.75%, while the one-year lending rate was lowered 40 bps to 5.6%.
The combined effect is likely to be growth neutral, with marginally cheaper credit for consumers and corporates offset by the disruption to the financial system as depositors shift funds.
It is debatable whether the cuts will be passed on to corporates. Lending rates were liberalised in 2013; the benchmark lending rate has been below the market lending rate ever since. Deposit rates, in contrast, are still tightly regulated, though the PBoC also loosened this regulation, allowing banks to offer a slightly wider band over the benchmark. The net result is likely to be little change in the deposit rate, though some banks have reportedly cut.
Some analysts are arguing the asymmetric nature of the cuts will be negative for bank margins, but with no pressure to cut lending rates, and some banks cutting deposit rates, the opposite could also be true. One negative for banks is that mortgages in China are typically floating and priced off the benchmark rate, so the repricing of mortgages in January will squeeze mortgage margins.
Will this mean a spurt of growth for China? The volume of lending in China is still constrained by quotas and other measures, so a big expansion of credit is unlikely. The move could then be positive for the property market and consumption, at the margin, but the effect will be limited. However, we expect further easing, in the form of reserve requirement ratio (RRR) cuts, additional rate cuts, and loan-deposit ratio (LDR) easing, in 2015 and 2016.
We still think the PBoC will move slowly and cautiously - the aim is still to slow credit growth, and good progress is being made on this front. RRR cuts will likely see a temporary increase in credit growth but will not relieve the pressure on the shadow financing system, which has driven much of the slowdown. Consequently, growth will continue to slow through 2015 and into 2016, as investment and real estate drag on performance. Our expectation is for rates to end 2015 at 5.2%, with the RRR cut 100 bps to 19%. Further cuts in 2016 will take the lending rate to 5% and the RRR to 18%.
In a separate measure, on Friday 28th November, the State Council published its deposit insurance scheme draft regulations. The scheme will cover RMB and FX deposits up to a value of RMB 500,000 and as a result covers 99.3% of deposits. The funding method has not been spelt out, but the PBoC has said the scheme would “pose little burden to financial institutions”.
The move has a number of implications. One is that financial reforms, delayed this year, may now start slotting into place. In particular, deposit rate liberalisation is now possible on a one to two year timeframe. Ultimately, this will also see a shift in the focus of monetary policy from quantitative controls to price based measures (i.e. inflation targeting and the use of policy rates over quotas).
Another is the impact of a shift from implicit to explicit state guarantees. The scheme creates a clear divide between the formal banking sector and the shadow finance system, and is likely to see depositors shift funds into banks, away from the shadow system. That the scheme has a cap could also see a redistribution of funds exceeding the limit within the banking system, and might even see a move away from smaller banks due to heightened risk awareness by depositors. Overall, we expect this to be a drag on lending activity, and by extension growth, in the months following implementation.
Overall, the combined effect is likely to be growth neutral, with marginally cheaper credit for consumers and corporates offset by the disruption to the financial system as depositors shift funds. We think credit growth will continue to decelerate. However, the fact that China is making progress on financial reforms is a welcome development.