MNI China Analysis: PBOC Unlikely to Follow Any Fed Rate Hike

     BEIJING (MNI) - Any rate hike by the U.S. Federal Reserve later this year

is unlikely to push the People's Bank of China into hiking its money market

rates because of the harm tighter monetary policy would do to the Chinese

economy.

     The U.S Federal Reserve's Open Markets Committee indicated last week that

it was likely to raise interest rates once more time this year. Fed Chair Janet

Yellen defended the rate hike plan in a speech Tuesday. 

     Market pricing now sees the probability of a Fed rate hike in December at

76.4%, according to CME Group.

     The PBOC raised its open-market rates twice in February and March this

year, after the Fed rose its interest rates last December and March. However,

the PBOC did not increase its rate after the Fed raised the fed funds rate

target by another 25 basis points in June. 

     As in June, the PBOC is unlikely to follow any Fed rate hike in coming

months with one of its own, for four reasons:

     First, recent Chinese economic data indicate that growth is slowing.

Industrial production and retail sales in August, as well as fixed-asset

investment in the year to date, all came in below expectations and below

year-on-year levels.

     Some analysts argue that much of the slowdown in August was due to the

government's campaign to reduce pollution, which forced some factories to cut

back operations and others to close. While this may be true to some extent,

growth is still expected to weaken in the fourth quarter as infrastructure

investment growth, which powered the economy in the first half of the year, is

curtailed by stricter rules on local government funding vehicles, and real

estate investment slows due to increasingly stringent government policies aimed

at curbing housing prices. 

     August financial data were in line with the weak economic data. The M2

money supply growth rate continued to probe record lows, falling to 8.9%

year-on-year in August from 9.2% in July. Total social financing grew CNY1.48

trillion in August, remaining strong, mainly due a healthy increase in new

loans, which rose CNY1.15 trillion. However, total social financing does not

reflect overall financing conditions accurately, as it only measures a part of

non-standard asset investments. The "shares and other types of investment" of

banks, reflecting broader non-standard asset investments, increased 9.4%

year-on-year, well below the 83.9% growth posted last August, according to the

PBOC. So the economy's financial condition may not be as strong as the TSF

figure suggests.

     Given the weaker growth outlook and questions about the health of financial

conditions as the PBOC continues its deleveraging campaign, raising rates in

response to the Fed would likely cause a further deterioration in the real

economy, which the government does not want to see.

     Second, a PBOC rate hike would lead to higher bond market yields, making it

more difficult for companies to raise funds via bond issues, the exact opposite

of what the government is trying to achieve. Net financing via corporate bonds

in the January to August period was a negative CNY8.5 billion, compared to a

positive CNY2.31 trillion in the same period last year.

     This sharp turnaround is due in large part to the higher yields seen

already this year, which caused many companies to cancel or delay new corporate

bonds issues. There have been a total of 506 corporate bond issuance delays or

cancellations from January to August this year, totaling CNY383.9 billion,

compared with 412 delays/cancellations worth CNY337.8 billion in the same period

last year.

     In its second quarter monetary policy report, the PBOC said it would "put

developing direct funding in an important position" and "improve the funding

structure of indirect financing." Therefore, tighter monetary policy is unlikely

because of the negative impact this would have on corporate bond issuance. 

     Third, a rate hike is unlikely given the strong possibility that the

government will announce stricter market regulations in the fourth quarter. The

market expects more regulatory policies to be announced after the 19th National

Congress ends in late October, as the government's financial risk prevention

campaign continues and even intensifies.

     Given the lesson learned from the "regulation storm" in April, when the

market was spooked by multiple regulations being announced within a few days,

and given the importance of regulatory coordination as stressed by the PBOC in

its second quarter monetary policy report, the PBOC is likely to avoid adding

higher interest rates to new regulations. On the contrary, the PBOC might loosen

monetary policy marginally, if needed, to maintain market stability as the

stricter regulations take effect.

     The most important reason for the PBOC to hike its rates in response to any

Fed's rate hike -- to keep the yuan exchange rate stable -- has become less

important. The yuan strengthened from 6.8908 on May 24 to 6.4617 on Sept. 8,

before partially retracing those gains in the past two weeks, falling to 6.6359

as of Wednesday. Still, the strong depreciation pressure evident earlier in the

year has eased. China's stock of foreign-exchange reserves also looks solid,

having increased each of the last six months from CNY2.998 trillion in February

to CNY3.092 trillion in August. 

     Even if yuan depreciation pressure were to resume and forex reserves were

to begin dropping again, the argument for China to increase domestic interest

rates to keep the exchange rate firm is not as strong as it was in the spring.

The State Administration of Foreign Exchange has demonstrated this year that it

has multiple tools, including stricter regulations on capital outflows, that can

help to stabilize the exchange rate.  

     Although a rate hike would help the exchange rate, the negative side

effects would be large, making the chance that the PBOC would raise rates quite

small.

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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