China’s rate cut - not if or when but by how much
- Bad debts and cash flow stress are forcing Beijing’s hand
- Cheaper funds would ease debt repayment pressures on local governments
- An asymmetric reduction of up to 50 basis points is on the cards
By Pauline Loong
Rising bad debts and tight cash flows pushing companies to the wall are concentrating minds in Beijing. Putting out immediate fires in the economy is taking on a new urgency as credit deterioration escalates and high funding costs wreck profits.
The question is no longer if or even when the Chinese central bank will cut interest rates but by how much. Beijing has to decide between the aggressive reductions needed to lower the real cost of funds in the face of disinflation or relatively modest moves that would be more prudent amid growing capital outflows and the prospect of higher US interest rates.
An asymmetric interest rate cut would give Beijing the best of both worlds.
Lowering the benchmark deposit rate – say by 25 basis points or less – would reduce funding costs for banks and encourage more domestic spending without raising pressures on capital outflows or exchange rates to unacceptable levels.
And lowering the benchmark lending rate – say by 40-50 bps – would ease the repayment pressures on local government financing vehicles facing an estimated Rmb1tr ($163 billion) in maturing debt this year and ease the debt servicing burden on corporates struggling with slowing revenues and liquidity problems.
Although the floor on lending rates was removed last year, policy directives would ensure that the benefits of a rates cut would flow through to borrowers on the government’s priority list.
Bad debts are rising rapidly
Banks are already reporting a rapid rise in bad debts. The non-performing loan ratio of all Chinese banking institutions (including policy banks and rural credit organizations) hit a five-year high in the fourth quarter of last year – increasing to 1.64% from 1.49% at the end of 2013.
Commercial banks share the pain. The NPL ratio of the sector rose for 13 consecutive quarters to 1.29% at end-2014, according to the China Banking Regulatory Commission.
But this could just be the tip of the NPL iceberg. Banking practices on the mainland are not exactly optimal for the recognition of bad debt.
One is the practice of “evergreening” where banks constantly roll over problem loans to keep them from going bad. Another is aggressive bad debt write-offs which doubled at the nation’s largest commercial banks last year to Rmb129 billion ($21 billion).
Chinese banks also tend to actively sell off bad debts rather than keep them on the books, unlike Japanese banks just after the bubble economy burst. The sale of problem loans has the blessing of Beijing which established asset management companies in the 1990s to take these loans off the books of the country’s biggest banks.
These distressed debt managers – which has been described as the carp of the Chinese financial landscape taking bites of all the garbage that comes its way – now come with deep pockets. China Huarong Asset Management is targeting a $2.5 billion float in Hong Kong following the listing of China Cinda Asset Management which raised $2.8 billion, 16 months ago.
And there is plenty of garbage to nibble on. Bad debts at China's 12 biggest listed banks jumped by more than a third last year. Their combined loan balance rose 11.49% over the previous year to Rmb 52.3 trillion ($8.44 trillion). The NPL balance on the other hand increased by a hefty 38.23% to Rmb 641.5 billion ($10.5 billion), according to a report by PwC. Their average NPL ratio rose 0.24 percentage points in 2014 to 1.23%.
But NPLs are lagging indicators. Overdue loans are better signposts to tomorrow’s bad debts. And overdue loans have increased at an even quicker pace than NPLs, according to the PwC report, increasing 112.65% over the previous year. The average overdue period has also been increasing which means these loans are moving closer to being non-performing.
Corporate debt is the highest in the world
Chinese corporate debt is the highest in the world. Former central bank adviser Yu Yongding put corporate borrowings at end-2013 at $14.2 trillion. This is higher than in any other country including the US which has company obligations estimated at $13.1 trillion by Standard & Poor’s.
Local government debt is no less substantial. The aggregate liabilities of local government financing vehicles stood at Rmb20.7 trillion in mid-2013 or $3.38 trillion at current exchange rates. Of this, an estimated Rmb1tr ($163 billion) falls due this year.
Two landmark defaults last week tell the story: a default on overseas debt for the first time by a property developer and a bond default for the first time by a state-owned company. And concerns are rising that there is more to come. See here
A dismal quarter
The economy’s performance so far has given no cause for cheer either. Domestic spending is down. Exports are down. Imports are down. Producer prices have been in negative territory for 37 straight months. And non-food consumer prices continue to fall.
Source: National Bureau of Statistics, Asia-analytica - Create your own charts with SaxoTrader. Click here to learn more
Retail sales dropped to a nine-year low of 10.2% in March. Exports tumbled 15% dragging quarterly growth down to 4.6%. Imports shrank 17.6% in the first quarter. Producer prices contracted 4.6% in March. Consumer prices went up 1.4% with non-food prices increasing by 0.9%.
The jobs market is softening. The ratio of jobs to applicants dropped to 1.12 in the first three months of this year from 1.15 in the previous quarter, according to the Ministry of Human Resources and Social Security.
While there are still more jobs than job-seekers, the trend is clearly worrying the government. Premier Li Keqiang said last month that the nation will roll out more measures to support growth if employment is at risk.
Lowering interest rates is not going to solve all the ills of the economy but it will help buy time for illiquid corporates with otherwise healthy balance sheets. And an asymmetric cut could help boost the flagging fortunes of the banking sector where net profit growth has shriveled to single digits for the first time in years.
-- Edited by Adam Courtenay
Pauline Loong is managing director of Asia-analytica Research. Follow Pauline or post your comment below to engage with Saxo Bank's social trading platform.
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