Download PBOC Monetary Policy Reform

Thomas Shik
Acting Chief Economist
[email protected]
PBOC Monetary Policy
Reform
• The People’s Bank of China (PBOC) cut
its benchmark interest rates and the
required reserve ratio (RRR) in October
in response to mainland China’s slower
economic growth and the persistence
of a weak inflation trend in mainland
China.
• The PBOC also took a final step
towards interest rate liberalisation by
removing the deposit rate ceiling,
suggesting that the benchmark deposit
and lending rates are now merely for
guidance only.
• Going forward, the PBOC may use
short-term reverse repo rates to guide
market interest rates. We expect that,
over time, changes in reverse repo
rates will provide a better indication of
the PBOC’s monetary policy stance
than that provided by benchmark rates.
Oct/Nov 2015
PBOC easing
On October 23 this year, the People’s Bank of China (PBOC) cut its benchmark
interest rates by 25 basis points, bringing the official one-year deposit and lending
rates down to 1.50% and 4.35% respectively (Exhibit 1) – the lowest on record for
both rates.
This was the sixth such move since November 2014, reflecting the further slowing
of economic growth and the persistence of the threat of disinflation in mainland
China.
The economy’s gross domestic product (GDP) rose by an annual rate of 6.9% in
the third quarter of this year, the slowest rate since the first quarter of 2009, after a
growth of 7.3% in 2014 and 7% in the first half of 2015 (Exhibit 2).
The traditional drivers of the Mainland economy have been particularly weak.
Industrial output growth has remained at its lowest rate in recent history and the
latest survey of purchasing managers has indicated contraction in the
manufacturing sector.
Exhibit 1: Benchmark Interest Rates
Exhibit 2: GDP Growth
Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank
October/November 2015
2
With the slowdown on the Mainland, inflationary pressures are limited, if not entirely
absent. Consumer price inflation is currently 1.3%, having stayed at or below 2%
for more than a year, and is now less than one half of the Central Government’s
target rate of 3%. Producer prices have fallen for 44 consecutive months, along
with sliding world commodity prices.
In addition, the GDP deflator, a broad
measure of inflation in the economy that, arguably, only reflects the prices of
domestically produced goods and services, turned negative in the third quarter for
the second time this year (Exhibit 3).
As we pointed out early this year, economic deleveraging has been taking place on
the Mainland.1 Therefore, output growth may continue to slow and inflation may
remain weak for some time. In these circumstances, the PBOC is likely to keep
monetary policy accommodative and assess the merits of any further rate cuts on a
month-by-month basis.
In announcing its most recent interest rate reduction, the central bank also lowered
the required reserve ratio (RRR) by 50 basis points for all commercial banks and by
an extra 50 basis points for those engaged in lending to the agriculture sector and
small enterprises. In June, we explained that slashing the RRR is a way to mitigate
the adverse impact of capital outflows on domestic monetary conditions.2 When
there are outflows and, in response, the PBOC sells foreign exchange assets (FX
assets) to maintain exchange rate stability, both the foreign exchange on the asset
side of the PBOC’s balance sheet and the deposits held by commercial banks at
the PBOC on the liability side will be reduced. If the RRR, which specifies how
much of a commercial bank’s deposits must be set aside as a reserve at the PBOC,
remains unchanged, commercial banks may then have to cut their lending to the
private sector to add funds to their reserve at the PBOC to meet the RRR.
Therefore, whether or not to adjust the RRR depends a lot on domestic monetary
conditions. We see a chance for the PBOC to cut the RRR by a further 50 basis
points to 17% by the end of the year (Exhibit 4).
1
2
Hang Seng Bank, China Economic Monthly, February 2015.
Hang Seng Bank, China Economic Monthly, June 2015.
October/November 2015
3
Exhibit 3: GDP Deflator
Exhibit 4: Required Reserve Ratio
Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank
The PBOC’s FX assets, a measure of cross-border capital flows,3 have dropped by
more than RMB1.2 trillion since January this year and now stand at about RMB25.8
trillion (Exhibit 5). With concerns about the vicious cycle of capital outflows, slowing
economic growth and the weakness of the renminbi (RMB), some are questioning
the adequacy of the Mainland’s foreign exchange reserves (FX reserves).
In theory, the PBOC’s FX assets should be identical to the Mainland’s FX reserves,
for which figures can be separately obtained from the State Administration of
Foreign Exchange (SAFE). But, in reality, there are discrepancies between the two
as FX assets are valued at historical costs in RMB, while FX reserves are
measured in USD and subject to valuation changes when exchange rates fluctuate.
According to SAFE, FX reserves have fallen by 12% from a record high of USD4
trillion in June 2014 to the current USD3.5 trillion (Exhibit 6). Although the decline
has been significant in amount, it is important to remember that the existence of FX
reserves reflects a country’s desire to maintain exchange rate stability and its value
is to prevent the country’s currency from falling when there are capital outflows. As
the Mainland is now open to more two-way volatility in RMB trading, the importance
of FX reserves has somewhat declined. This can be seen in the way that the
Mainland has just prevented the RMB from falling significantly by making use of its
FX reserves to meet outflows but, if it later implements a floating exchange rate
system, the size of FX reserves should no longer be a major matter of concern.
3
Hang Seng Bank, China Economic Monthly, March 2015.
October/November 2015
4
Exhibit 5: FX Assets (monthly change)
Exhibit 6: FX Assets & FX Reserves
Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank
Policy reform
In addition to reducing benchmark interest rates and the RRR, the PBOC took a
final step towards full interest rate liberalisation on 23 October this year by lifting the
deposit rate ceiling once and for all. Before this development, banks were free to
set their own lending rates but were only allowed to set deposit rates that were up
to 50% above the benchmark rate. The central bank has stated that the move to
give banks more freedom has been driven partly by the fact that many financial
institutions had already entered the market selling wealth management products
that offer depositors higher interest rates than the deposit rate cap.4
Following this move, the PBOC no longer controls the deposit and lending rates
that are applicable to transactions between banks and their customers.
This
development will allow the market to play a decisive role in allocating capital, as
pledged by the authorities following the Mainland’s Third Plenum meeting in
November 2013.
With interest rate deregulation, banks should be able to charge different borrowers
different interest rates, according to their credit risks. But, to facilitate information
exchange, there would be a need for a reference rate indicating to the market what
price banks are generally setting on their loans under prevailing monetary
conditions. This reference rate is commonly called the prime rate.
4
http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968751/index.html
October/November 2015
5
In the US, the prime rate tends to move closely with the Federal Reserve’s policy
rate (Fed funds target) and the spread between the two has been fairly stable
(Exhibit 7). It is typically uniform across major commercial banks, which use it as a
base rate for many types of loans.
On the Mainland, the PBOC officially introduced the loan prime rate (LPR) in
October 2013 (Exhibit 8). It is set by asking nine commercial banks to submit their
best lending rates which are then used to calculate a weighted average on a daily
basis.
By removing controls on market interest rates, the PBOC is now
encouraging banks to actively use the LPR as a base rate for their loans to the
private sector.5
Exhibit 7: US Fed Funds Target vs Prime Rate
Exhibit 8: Mainland’s Loan Prime Rate
Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank
Interest rate deregulation also means that the PBOC’s benchmark deposit and
lending rates are now merely for guidance only. The central bank may therefore
have to set a new policy rate – usually a target level for the short-term interest rate
in the wholesale interbank market – through which it can affect a range of other
interest rates in the retail banking market and, ultimately, influence the state of the
economy. This would formally mark a shift in approach for the PBOC - from setting
the quantity of money by adjusting loan quotas and issuing window guidance, to
setting the price of money by determining the policy rate through which it can
influence market interest rates and hence economic activity.
5
http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968751/index.html
October/November 2015
6
But why is this change in the use of policy tools by the PBOC important? First,
capital account opening is resulting in more cross-border capital flows, and it is
getting increasingly difficult for the PBOC to control the quantity of money that it
deems suitable for the domestic economy.
Second, rising cross-border capital
flows is also making it more difficult for the PBOC to continue to control interest
rates at the retail banking level. Against this backdrop, there is a growing need for
the central bank to shift its focus to targeting interbank interest rates instead of
retail market interest rates.
The PBOC has made it clear that it will make more use of short-term reverse repo
rates to guide market interest rates going forward.6 Its policy framework has also
been taking shape and is increasingly more akin to the one in the US or the
Eurozone (Exhibit 9).
Exhibit 9: Interest Rate Corridor
Upper-end
(%)
Target rate
(%)
Lower-end
(%)
People’s Bank of China
US Federal Reserve
European Central Bank
Standing lending facility
Discount window
Marginal lending facility
(2.75% overnight)
(0.75%)
(0.30%)
Reverse repo
Fed funds target rate
(not specified, currently
about 1.8% overnight)
Main refinancing
operations
(0-0.25%)
(0.05%)
Interest rate on
excess reserves
Interest rate on
excess reserves
Deposit facility
(0.72%)
(0.25%)
(-0.20%)
Source: PBOC, Federal Reserve, European Central Bank, Hang Seng Bank
6
http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968751/index.html
Reverse repo transactions are usually at maturities of 7 days, 14 days, and 28 days.
October/November 2015
7
Specifically, the PBOC appears to be moving to adopt an interest rate corridor
system, under which it brackets its desired level of short-term reverse repo rates
with the interest rate on the Standing Lending Facility (SLF) above and the interest
rate on excess reserves parked at the PBOC by commercial banks below. The
central bank may use open market operations to adjust the supply of liquidity so as
to keep reverse repo rates at its target level. And under this corridor system, the
ability of banks to borrow from the PBOC at the interest rate on the SLF, which is
designed for the purpose of meeting banks’ short-term liquidity needs, should put a
cap on reverse repo rates, while the ability of banks to earn interest by parking
money at the PBOC should set a floor on reverse repo rates.
Concluding remarks
Overall, the PBOC is shifting its focus from control of retail market interest rates to
control of interbank interest rates. The benchmark deposit and lending rates are
now guidance, not requirements.
We believe that changes resulting from the
PBOC’s open-market operations in reverse repo rates should, over time, provide a
better indication of the PBOC’s monetary policy stance than that provided by
benchmark deposit and lending rates.
October/November 2015
8
China Economic Monitor Statistics
November 2015
Industrial
output
GDP
Fixed asset
investment
Foreign trade
Retail sales
Nominal
Real
Real
Nominal
Nominal
Exports
Imports
Consumer prices
Trade balance
Food
Non-food
RMB bn
yoy (%)
yoy (%)
ytd (%)
yoy (%)
yoy (%)
yoy (%)
USD bn
yoy (%)
yoy (%)
yoy (%)
2010
40,151
10.6
15.7
24.5
18.4
31.3
38.7
183.1
3.3
7.2
1.4
2011
47,310
9.5
13.9
23.8
17.1
20.3
24.9
155.1
5.4
11.8
2.7
2012
51,947
7.7
10.0
20.6
14.3
7.9
4.3
231.1
2.6
4.9
1.6
2013
58,802
7.7
9.7
19.6
13.1
7.9
7.3
259.7
2.6
4.7
1.6
2014
63,614
7.3
8.3
15.7
12.0
6.1
0.4
382.5
2.0
3.1
1.5
NA
7.0
6.5
11.0
10.5
0.0
-12.0
621.7
1.5
2.5
1.0
Q1 2014
13,874
7.3
8.7
17.6
12.0
-3.4
1.6
16.7
2.3
3.5
1.7
Q2
15,520
7.4
8.9
17.3
12.3
5.0
1.6
86.0
2.2
3.4
1.7
Q3
16,347
7.2
8.0
16.1
11.9
13.0
1.2
128.0
2.0
3.0
1.5
Q4
17,873
7.2
7.6
15.7
11.7
8.5
-1.6
149.5
1.5
2.6
1.0
Q1 2015
14,796
7.0
6.4
13.5
10.6
4.7
-17.6
123.9
1.2
1.9
0.8
Q2
16,622
7.0
6.3
11.4
10.2
-2.2
-13.6
140.2
1.4
2.1
1.0
Q3
17,360
6.9
5.9
10.3
10.7
-5.8
-14.1
163.6
1.7
3.0
1.1
Jun 2015
NA
NA
6.8
11.4
10.6
2.8
-6.1
46.5
1.4
1.9
1.2
Jul
NA
NA
6.0
11.2
10.5
-8.3
-8.1
43.0
1.6
2.7
1.1
Aug
NA
NA
6.1
10.9
10.8
-5.5
-13.8
60.2
2.0
3.7
1.1
Sep
NA
NA
5.7
10.3
10.9
-3.7
-20.4
60.3
1.6
2.7
1.0
Oct
NA
NA
5.6
10.2
11.0
-6.9
-18.8
61.6
1.3
1.9
0.9
48,778
6.9
6.1
10.2
10.6
-2.4
-15.0
489.3
1.4
2.3
1.0
2015F
YTD
Deposits
(domestic currency)
Loans
(domestic currency)
Lending rate
New loans
Money supply
(M2)
Forex
reserves
Foreign direct
investment CNY per USD
(period end)
Total social
financing
1-year
RMB bn
yoy (%)
RMB bn
yoy (%)
RMB bn
%
yoy (%)
2010
71,823
20.2
47,920
19.9
7,950
5.81
19.7
USD bn
2,847
ytd (%)
17.4
6.5897
RMB bn
14,019
2011
80,940
13.5
54,790
15.8
7,470
6.56
13.6
3,181
9.7
6.2940
12,829
2012
91,740
13.3
62,990
15.0
8,200
6.00
13.8
3,312
-3.7
6.2303
15,760
2013
104,380
13.8
71,900
14.1
8,890
6.00
13.6
3,820
5.3
6.0543
17,290
2014
113,860
9.1
81,680
13.6
9,780
5.60
12.2
3,840
1.7
6.2055
16,460
2015F
122,969
8.0
91,680
12.2
10,000
4.35
12.0
3,800
2.0
6.50
17,000
Q1 2014
109,100
11.4
74,910
13.9
3,010
6.00
12.1
3,948
5.5
6.2171
5,600
Q2
113,610
12.6
77,630
14.0
2,726
6.00
14.7
3,993
2.2
6.2031
4,920
Q3
112,660
9.3
79,580
13.2
1,945
6.00
12.9
3,888
-1.4
6.1394
2,280
Q4
113,860
9.1
81,680
13.6
2,098
5.60
12.2
3,843
1.7
6.2055
3,503
Q1 2015
124,887
10.1
85,907
14.0
3,671
5.35
11.6
3,730
10.6
6.1997
4,644
Q2
131,829
10.7
88,795
13.4
2,880
4.85
11.8
3,694
8.0
6.2010
4,125
Q3
133,734
12.6
92,134
15.4
3,341
4.60
13.1
3,514
8.6
6.3560
3,131
Jun 2015
131,829
10.7
88,795
13.4
1,271
4.85
11.8
3,694
8.0
6.2010
1,833
Jul
134,000
13.4
90,273
15.5
1,480
4.85
13.3
3,651
7.7
6.2097
742
Aug
134,053
13.0
91,082
15.4
810
4.60
13.3
3,557
8.9
6.3790
1,086
Sep
133,734
12.6
92,134
15.4
1,051
4.60
13.1
3,514
8.6
6.3560
1,303
Oct
134,312
12.7
92,647
15.4
514
4.35
13.5
3,526
8.6
6.3174
477
YTD
134,312
12.7
92,647
15.4
10,414
4.35
13.5
3,526
8.6
6.3174
12,376
NA: not available; (A)= actual; (F)= HASE forecast; yoy= year-on-year; ytd= year-to-date
Source: State Statistical Bureau, China Statistical Yearbook, Macrobond, CEIC, Bloomberg, Hang Seng Bank
October/November 2015
9
GDP Growth
Source: Macrobond, Hang Seng Bank
Urban Fixed Asset Investment
Source: Macrobond, Hang Seng Bank
Loan & Deposit
Source: Macrobond, Hang Seng Bank
Benchmark Interest Rates
Source: Macrobond, Hang Seng Bank
October/November 2015
Consumer Price Inflation
Source: Macrobond, Hang Seng Bank
Retail Sales
Source: Macrobond, Hang Seng Bank
Money Supply (M2)
Source: Macrobond, Hang Seng Bank
Exports & Imports
Source: Macrobond, Hang Seng Bank
10
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October/November 2015
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