MNI Interview: Nomura China Economist Sees Full RRR Cut Coming

--Bond Default Risk To Rise Due To Tighter Regulation

--Exports Expected To Slow As Yuan REER Picks Up

     BEIJING (MNI) - The People's Bank of China is likely to make an overall cut

to banks' reserve requirement ratio in the second half of 2018 as the economy

slows and the government's deleveraging campaign takes firmer hold, Zhao Yang,

China chief economist at Nomura, the Japanese global investment bank, told

Market News in an interview.

     Zhao, previously a senior official with the Hong Kong Monetary Authority,

also told MNI that the risk for corporate bond defaults would increase next year

and that a slowdown in China's export trade would act as a drag on the economy. 

     The PBOC has repeatedly stressed its "neutral and prudent" monetary policy

stance amid the government's deleveraging campaign, and it has been trying to

avoid sending any signals of loosening to the market, particularly regarding any

overall cut to the reserve requirement ratio.

     But Zhao expects the market to see two RRR cuts in the coming year -- the

targeted one the PBOC announced in September that it will implement on Jan. 1,

and an overall trimming of the RRR in the second half of the year.

     The Jan. 1 targeted cut -- the first since February 2016 -- is intended to

encourage inclusive financing at commercial banks, offering credit support for

small and micro-sized enterprises, startups and agricultural projects. According

to the central bank, all qualified banks will enjoy a 50 basis points RRR cut.

The measure is aimed at supporting small businesses and creating new jobs and

growth.

     "I think the strength [of the targeted RRR cut] will be close to that of an

overall cut since it will cover most banks," Zhao said, before adding that he

believed an overall cut is also necessary to avoid a sharp fall in loan growth

and aggregate financing.

     "We expect a 50bps RRR cut in the second half of 2018 to hedge risks of

capital outflows caused by the U.S. Fed's rate hikes and buffer the possible

liquidity crunch due to tight financial regulations," Zhao explained. "The PBOC

needs to consider liquidity levels while it pushes forward deleveraging at an

aggressive pace."

     Meanwhile, the government's policy rates -- including open-market operation

rates and monetary instrument rates -- should see gradual hikes, but an increase

in the benchmark interest rate will not be an option for the central bank, Zhao

said.

     "The [PBOC's] monetary policy is aimed at downplaying the influence of the

benchmark interest rate. We can see that commercial banks are able to float

their interest rates based on the benchmark ones," Zhao noted. "Current real

loan rates are already high, including mortgage rates. So unless inflation

surges above 3%, the psychological threshold for policy-makers, they would not

touch the benchmark interest rate."

     --GREATER BOND DEFAULT RISK

     Financial regulations are expected to tighten even further after regulators

launched draft rules last month covering asset management products -- with banks

no longer able to guarantee returns on their ubiquitous and relatively

high-yielding wealth management products.

     More rules are expected to be implemented to head off other liquidity

risks, impacting firms' ability to raise funds.

     "As the economy slows and regulations tighten, companies with heavier debt

burdens and lower credit will face more pressure as their financing costs

continue to rise. Pressure on their default risk will increase," Zhao said. "As

small banks are more involved with shadow banking business and vulnerable to

debt defaults, we expect increasing credit differentiation between large and

small banks."

     The financial deleveraging campaign will increase the pessimism of market

participants, which will make investors more aware of credit risk and therefore

demand higher premiums where applicable, Zhao noted

     As for local government bonds, they remain a relatively safe debt, as the

government will continue to safeguard them on any default. 

     "Municipal bonds in China are different from those in the U.S., considering

Chinese local governments are affiliated to the central government, rather than

an independent fiscal authority, so any default of local government bonds would

hurt the reputation of the overall regime," Zhao argued.  "The Chinese

government will not allow it [default of a local government bond] to occur."

     --EXPORTS TO ACT AS DRAG

     Exports are widely expected to continue to be a driver of economic growth

next year, considering robust overseas demand. In the first 11 months of this

year, exports were up 8% y/y, compared with a 7.89% decline during the same

period last year.

     However, Zhao said that the current level of export growth is not

sustainable and would come down, putting pressure on economic growth.

     "The rapid depreciation of China's real effective exchange rate [REER] in

2016 helped exports this year, considering the REER has a leading relationship

with exports of about six months," Zhao said, "According to our model, the

depreciation of China's REER has moderated significantly since the first quarter

of 2017 and is now about to enter appreciation territory, so the recent pick-up

in REER growth should be a drag on exports next year."

     In addition, trade tensions between China and the U.S should continue,

which will weigh on China's exports for a prolonged period, Zhao added.

     Nomura expects a long-lasting slowdown of the Chinese economy through

2018-19, weighed by a slowdown in investment, a tighter credit cycle and

structural reforms. Its forecast for GDP growth in 2018 is 6.4%, and even lower

should the CPI unexpectedly rise, property regulations become tighter and

property prices drop further.

     But China's new GDP methodology, which is more in line with international

standards,  could be somewhat of a a silver lining for GDP numbers. "We estimate

the adoption of the new accounts system to add a possible 0.3 percentage points

to 2018 GDP growth," Zhao said.

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

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

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