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REPEAT:MNI Interview: Nomura China Economist Sees Full RRR Cut

Repeats Story Initially Transmitted at 05:01 GMT Dec 20/00:01 EST Dec 20
--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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