China’s near-term macro outlook amid interbank rates volatility and government reform effort – June 27, 2013
The interbank rates volatility is the most significant event in China over the past two weeks. The overnight rate at Shanghai Interbank jumped from 4.50% on May 31st to the high of 13.44% on June 20th, and closed 5.55% on June 26th. The People’s Bank of China (PBoC) public statement on June 25th vowed to use various monetary policy tools to stabilize liquidity in the banking system in the future. Shibor 1W (Shanghai Interbank Offered Rate) surged from 4.78% on May 31st to the high of 11.00% on June 20th, before dropping to 7.20% on June 26th.
We believe this Shibor surge is engineered by the PBoC to punish smaller banks who have abused the interbank system, and to slow down non-bank credit growth. By doing nothing to stop the Shibor spike, it is trying to send out a signal that they are not going to loosen the monetary stance, especially when the recent Shibor surge was mainly due to some banks’ aggressive expansion of their interbank positions in recent months. In contrast, they want to hold back banks (particularly the small and medium sized ones) from aggressively lending or issuing wealth management products on interbank financing. At the moment there is no evidence showing that the tight liquidity is a systematic issue. Given the loan-to deposit ratio cap in China, there is no excessive reliance on the interbank market overall, unlike the western banks during the global financial crisis.
However, the tight liquidity may have an impact on the already weak near-term economic growth. Even though Shibor rates have fallen after PBoC’s statement, it remains higher than the average level in January-May before the surge. This has started to impact other markets such as equity and bond markets. The CSI 300 Index (Chinese A shares) dropped by 16% since the end of May. China’s discount bill rates have surged as well. The 6-month discount bill rates spiked to over 7%. The discount bill is an important funding instrument for small and medium enterprises, and higher discount bill rates have implications to the second half of 2013 gross domestic product (GDP) outlook. In the past 5 years, the surge of discount bill rates has always corresponded with a sharp slowdown in economic growth.
The slowdown in credit growth support, likely higher credit cost, and seasonality could continue to weigh on China’s GDP performance in the second and third quarters of 2013. The first quarter 2013 GDP growth of 7.7% already fell short of expectations, when a surge of GDP growth to 7.9% in the fourth quarter 2012 made the consensus believe the worst should have been over. On the investment side (the driver for GPD growth), manufacturing capital expenditure will remain weak, given concerns on overcapacity. The crackdown on shadow banking could eventually have a negative impact on infrastructure and property investment, as the majority of trust product funding goes to these sectors. Consumption could eventually pick up following all the reform initiatives including the income distribution reform and urbanization, but in the short-term may remain modest given the government’s continuous anti-corruption effort.
Source: CEIC as of June 27, 2013
The key message from the recent Shibor volatility is that the Chinese government is now willing to tolerate slower near-term growth while carrying out reform to rebalance the economy for long term sustainable growth. The diminishing demographic dividend as a result of the aging population and One-Child Policy will result in slower potential growth for the economy. In addition, the state dominance of the economy may continue to result in low productivity gains, inefficient use of resources, and declining ICOR (Incremental Capital Output Ratio). It also has a significant negative impact on the environment. In order for China to lift its long-term sustainable growth, it is necessary to level the playing field and improve productivity gains. From this, we can form our framework to understand most of the recent and ongoing reform initiatives, such as the deregulation of government approval on investment projects, tax cuts, resource tax reform, Hukou reform, and financial sector reform including opening up of the capital account and interest rate liberalization.
Premier Li Keqiang is telling people that China’s reform effort is serious. However, the reform effort will have a cost, as it is fighting vested interest groups. Zhu Rongji was the last Premier who pushed forward a series of significant reform during the 1998 to 2003 period including transforming banks from policy banks to commercial banks, state owned enterprises reform, tax reform and property reform. However, he is the only Premier in recent years that only serviced one term (1998-2003), compared with his predecessor Li Peng (1987-1998), and his successor Wen Jiabao (2003-2013). Nevertheless, what Zhu did during his term eventually helped China recover from the downturn cycle after the Asian Financial crisis and pave the way for its subsequent pickup of economic growth in the early-to-mid 2000s and the big bull market in 2006-07.
China quarterly GDP year-over-year growth
Source: Bloomberg, NAM as of June 27, 2013
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