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Lowering rates ‘a brave move’, more easing in the pipeline
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WE believe the banks will fully utilize the upward flexibility so the one-year benchmark deposit rate will rise to 3.3 percent, the same as currently.
It remains to be seen how much of the cut in the lending rate will get passed on to the borrower as banks face a squeeze in the interest rate margin from this announcement.
China’s bank lending rates are fully liberalized and as of September, banks were charging 71.3 percent of their loans above the benchmark rate, 20.4 percent equal with the benchmark and 8.3 percent below the benchmark.
While banks are unwilling to pass on all the cuts in the benchmark rates, we note that many loans are with long-term customers. We think banks are likely to deliver more than 50 percent of the reduction in the benchmark lending rate.
We think the 40 basis-point cut is a brave move and probably necessary for the lending rate cut to be effectively passed on to the real economy to support demand.
‘Rate cuts unavoidable’
We have long been arguing “cuts in the benchmark rate are unavoidable” and “a lower interest rate environment will help to facilitate the transition of the Chinese economy”. We officially forecast two benchmark interest rate cuts since late June, given our judgment of: 1) targeted easing measures will be ineffective to lower the financing costs; 2) risks to growth are on the downside amid the property market downturn; 3) real interest rates have been too high and are rising amid falling inflation; and 4) the economy’s high debt/GDP of 250 percent.
The market will likely read this as a positive signal that the Chinese government is responding to worsening private demand and rising deflation risks and is finally willing to send a strong signal to the market. We think the disappointing traffic in the first week of the Shanghai-Hong Kong Stock Connect may have been a driving factor.
The Chinese economy continues to face many challenges: deflating of the property bubble, industrial overcapacity, significant financial risks in the official and shadow banking sector to name a few, plus the urgent need to deliver market-oriented reforms. We have argued that lowering the interest rate will help to reduce the debt burden, lower financial risks, support business sentiment, and sustain private demand.
Our call had been two cuts in the benchmark rates of 25 basis points each in the fourth quarter of 2014 and the first quarter of 2015.
After evaluating the effect of the asymmetric move, we are now looking for another two symmetric cuts in benchmark interest rates, 25 basis points each in the first half of 2015.
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