Download China`s new monetary policy framework

November 2014
China’s new monetary policy framework
Please refer to pages 67 – 68 of this report for important disclosure and analyst certification information.
19 November 2014
China macro monitor
China monetary policy framework in transition
The framework of China’s monetary policy is in transition, from using a dollar-centric
exchange rate as a nominal anchor to one using a market-based, interest rate.
Currently, there is a mixture of both quantity- and price-based instruments, the main
ones being the required reserve ratio (RRR), deposit and lending rates, open market
operation (OMO) and loan quotas. In acknowledging the importance of further
financial liberalisation, as well as the market distortion from quantity-based tools,
China’s policy framework is in the process of shifting away from quantity-based tools
to more price-based tools (see China’s new monetary policy framework: Status,
outstanding issues & outlook, 14 November).
However, with reference to monetary policy innovation in some economies since the
global financial crisis, the PBOC, in January 2013, began to use more innovative, but
quantity-based tools to manage monetary conditions in specific sectors. In its 3Q14
monetary policy report, the PBOC reiterated its preference for such tools, including
standing lending facilities (SLF), medium-term lending facilities (MLF), pledged
supplementary lending (PSL) and short-term liquidity (SLO), which all aim to
influence market-based interest rates such as SHIBOR and interbank repo rates. So,
rather than using conventional tools, the PBOC has turned to new instruments. For
example, it injected CNY770b into the economy through MLF, which is equivalent to
a 75bp RRR cut (see Deflationary environment conducive to further monetary easing
by the PBOC, 10 November).
Debates on China’s new monetary policy instruments
Since April 2014, we have been arguing that the PBOC needs to ease monetary
policy, in the form of interest rate and RRR cuts, initially to compensate for the
deleveraging effect from shadow-banking consolidation, and then to lower market
interest rates and provide an accommodative credit environment (see More onbalance-sheet easing needed amid shadow-banking consolidation, 15 April).
In our view, these new monetary policy instruments could have important drawbacks
to China’s policy reform and RMB internationalization (see PSL: Innovation or
setback to China’s monetary-policy reform? 23 July), as they: 1) lack transparency
and broad-based market participation; 2) are a step backwards in terms of China’s
financial marketization; 3) are a misuse of the PBOC’s mechanisms; and 4) confuse
the role of other government departments.
Structurally, these tools also compromise the achievements in structural reform the
government has made so far. Renminbi internationalization has been a top priority for
the central bank, and interest rate liberalization is an important part of it. The marketdriven interest-rate framework is not yet fully formed, with problems communicating
between the government’s guidance, the interbank rate at the wholesale level and
retail rates in the credit markets. We believe the government’s direct manipulation of
interest rates at the retail end could jeopardize the efforts made thus far.
RRR and interest rate cuts are inevitable
Jianguang Shen
[email protected]
+852 2685 2022
Michael Luk
[email protected]
+852 2685 2155
In our view, targeted measures reflect the multiple objectives of the PBOC. The
central bank has six objectives: 1) low inflation; 2) reasonable economic growth;
3) employment creation; 4) neutral balance of payments; 5) financial stability; and
6) structural reform. Using targeted monetary measures to achieve these goals,
however, tends to be economically inefficient. Instead, we believe the government
should work on increasing PBOC independence, and return it to its traditional role
and tools, focus on increasing the effectiveness of monetary policy, such as by
increasing communication with the market, and improve market disclosure.
Going forward, as China: 1) continues its downward growth trend; 2) enters a
deflationary environment; and 3) suffers from high financing costs in the credit market
– especially the small- and medium-sized enterprises (SME), rural sectors and new
industries, which are deprived of credit access – we believe conventional easing,
including RRR and interest rate cuts, is necessary, beginning from end-2014, at the
earliest (see Weak data fits in with a lower 2015 growth target, 13 November).
Please refer to pages 67 – 68 of this report for important disclosure and analyst certification information.
China macro monitor
Table of contents
China’s new monetary policy framework: Status, outstanding issues & outlook
3
Three new cases of shadow-banking risk
19
Weak credit data calls for RRR & rate cuts
38
Deflationary environment conducive to further monetary easing by the PBoC
40
Another round of stealthy monetary easing
44
Monetary easing to accelerate
46
Deflation risk calls for rate cuts
50
Stealthy monetary easing to avert hard-landing risk
54
First targeted interest rate cut heralds additional stimulus
56
Weak credit data not a sign of tightening
58
PBoC signals monetary easing to continue
61
PSL: Innovation or setback to China’s monetary-policy reform?
64
2
Economics Update
14 November 2014
China’s new monetary policy framework:
Status, outstanding issues & outlook
 China’s new monetary framework began as a discussion about the global
financial crisis, as a response to the innovative tools invented by developed
economies. In addition to conventional quantity-based and price-based tools,
since 2013 China has launched a number of new monetary policy instruments
such as standing lending facility (SLF), medium-term lending facility (MLF),
pledged supplementary lending (PSL) and short-term liquidity (SLO).
 We believe these new targeted tools lack transparency and are unnecessary, as
China and the US face very different constraints. For example, QE in the US was
the solution after regular policy tools are exhausted. Meanwhile over the past two
years China has a great opportunity to push forward financial-market reform. We
believe the government should be working on interest rate liberalization and
establishing a market-based term structure of interest rates and that these new
policy tools are steps backward that risk reversing the government’s previous
efforts.
 However, the PBoC has been required to serve multiple objectives; some of them
are difficult to achieve using broad-stroke monetary instruments. In our view, the
government should work on both increasing its independence and lowering its
expectation to push forward structural reforms through monetary policy. The
PBoC should also focus on increasing the effectiveness of monetary policy, such
as by increasing communication with the market, and improving market
disclosure.
3
Economics Update
Global monetary policy since the crisis
China’s new monetary framework began as a discussion about the global financial crisis and
as an assessment of the responses by the central banks around the world. During the crisis,
many central banks, led by the US Fed launched quantitative easing (QE) and forwardlooking guidance when traditional monetary tools failed to function. Such tools were
innovative area in central bank policymaking:
More flexible monetary policy objectives
The framework for monetary policy includes a wide range of topics in policy making and
execution, such as manipulation of various policy tools; operational targets, intermediate
targets and ultimate targets; institutional arrangements between the central bank and the
government; and monetary and fiscal policy as well as their implication on FX and
international balance of payments.
Since the stagflation in the west in the 1970s, neo-classical and neo-Keynesian schools of
economics began an extended debate on inflation as the ultimate target of monetary policy.
As the two schools debated on rational expectations, sticky price and monetary nonneutrality, the framework for modern monetary policy was born. Generally, central bankers
now believe in affecting the real economy through monetary adjustments, and maintaining
steady price levels, given the huge cost of high inflation on social welfare.
Inflation-targeting monetary policy has since gained widespread acceptance. Starting with
New Zealand in 1990, the central banks of Chile, Canada, Australia, Brazil, Finland, Israel,
Poland, South Africa, Spain, Sweden, Korea, Thailand and Switzerland have adopted this as
their objectives in monetary policy. The European Central Bank (ECB), Bank of Japan and
Bank of England have also set steady price levels as the only goal in monetary policy. The
ECB in particular defined steady price level as having the Harmonised Index of Consumer
Prices (HICP) below 2% in the short-term and near 2% in the medium term.
In comparison, the Fed has had the dual objective of maximizing employment and
maintaining steady price levels, while keeping inflation at 2%. Along with the challenges of
the financial crisis, employment has recently become the focus of the Fed. According to Fed
chair Janet Yellen, the Fed has adopted a framework of flexible-inflation targeting to balance
price stability and maximum employment. In practice, however, employment has clearly
received more attention as policy becomes more flexible.
Fig 1 US employment market is improving
Em ploym ent
11
700
500
10
300
9
'000 persons
100
-100
7
-300
%
8
-500
6
-700
5
4
Sep-08
-900
Jun-09
Mar-10
Dec-10
Sep-11
Non-farm payroll (RHS)
Source: Wind, Mizuho research
4
Jun-12
Mar-13
Unemployment rate
Dec-13
-1,100
Sep-14
Economics Update
Relying on QE
Until recently, central banks in the West relied on price-based tools more than quantity-based
tools. Taylor’s rule was the most common guidance in setting interest rates. Introduced by
economist John Taylor in 1993, the rule provides guideline to set interest rates in relation to
changes in inflation, output gap and other economic conditions that will stabilize the
economy in the short term and maintain long-term growth. However, according to Taylors’s
rule since the global financial crisis began, central banks should be prescribing negative
interest rates. This is difficult to follow in practice, so it provided the justification for QE.
As Chairman Zhou Xiaochuan of the PBoC noted at the Tsinghua Wudaokou Finance Forum,
central bankers would have to rely on quantity-based monetary easing where price-based
tools such as interest rates have reached the bottom. The three rounds of QE and Operation
Twist led to the largest expansion of the Fed’s balance sheet since World War II, doubling to
USD4.5t within the past five years.
Fig 2 The Fed’s balance sheet expansion is ahead of the world
Balance sheet
600
Jan 2007=100
500
400
300
200
100
0
Jan-07
Jan-08
Jan-09
Jan-10
Fed
BOJ
Jan-11
Jan-12
BOE
Jan-13
Jan-14
ECB
Source: Wind, Mizuho research
Managing expectations with forward guidance
In addition to QE, to support economic recovery the Fed also used forward guidance about
its targets, when then chair Ben Bernanke declared in December 2012 that the Fed would
not raise interest rates until America’s unemployment rate dropped to at least 6.5% providing
that inflation was still below 2.5%. Forward guidance was based on the view that good
communication between the central bank and the market would help build market
expectations and give credibility to the central bank’s monetary policy. The first time the Fed
adopted threshold guidance to replace calendar guidance was in January 2012, and it
effectively gave the guidance a suitable timeframe.
Macro-prudent policy not officially a part of the Fed’s framework
Another phrase popularized during the financial crisis was “macro-prudential policy”, which
characterizes an approach to financial regulation aimed at mitigating systemic risk within the
financial system. However, we found that such policy has not been formally adopted as a
part of the Fed’s policy framework.
Generally, macro-prudential policy compliments the Fed’s monetary policy of reducing the
macroeconomic costs of financial instability. It is recognized as a necessary ingredient to fill
the gap between macroeconomic policy and the traditional micro-prudential regulation of
financial institutions.
5
Economics Update
Since the crisis, innovative policy development by the Fed has created positive short-term
results in terms of economic recovery and employment as well as the theory and practice of
monetary policy. In our view, however, it also shows that the framework for monetary policy is
difficult to define. Yellen’s comments suggest her monetary policy framework has become an
increasingly fluid concept that depends on the employment situation, in our view.
Limitations of monetary policy
The innovative tools in QE are not without controversy. In our view, Yellen’s policy is
increasingly aligned with Greenspan’s, in expecting monetary policy to help all things,
including the employment market. In mid-October, for example, she decried widening income
inequality in the US, even though in our view such problems cannot be solved by
conventional monetary policy.
We believe that the intrinsic problems in the US economy – including delays in structural
reforms, low production efficiency, high consumption, low saving and falling share of
manufacturing in GDP – make the asset-driven recovery in US difficult to sustain.
Fig 3 Monetary policy innovation in the US helped with economic recovery
GDP contribution by expenditure
6
5
4
3
%
2
1
0
-1
-2
-3
-4
Sep-14 Jun-14 Mar-14 Dec-13 Sep-13 Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Mar-12 Dec-11
PCE
Investment
Inventory
Net exports
Government
Real GDP
Source: Wind, Mizuho research
Fig 4 QE led to rising asset prices in the US
20
S&P/Case-Shiller 20-city composite home price
Index
15
Dow Jones
20,000
18,000
10
%
5
16,000
0
14,000
-5
12,000
-10
10,000
-15
8,000
-20
-25
Aug-02 Aug-04 Aug-06 Aug-08 Aug-10 Aug-12 Aug-14
6,000
Nov-04
Source: Wind, Mizuho research
6
Nov-06
Nov-08
Nov-10
Nov-12
Nov-14
Economics Update
Fig 5 Economic restructuring in the US remained slow, with low income growth in manufacturing
170
Average weekly earnings
160
2007=100
150
140
130
120
110
100
90
80
Sep-99
Sep-02
Sep-05
Construction
Sep-08
Sep-11
Manufacturing
Sep-14
Financial
Source: Wind, Mizuho research
Fig 6 Non-oil trade deficit rising in the US
Trade balance
0
-10
USD b
-20
-30
-40
-50
-60
Sep-90
Sep-94
Sep-98
Non-oil products
Sep-02
oil and oil products
Source: Wind, Mizuho research
7
Sep-06
Sep-10
Automobile and parts
Sep-14
Economics Update
China’s monetary policy framework: Status
Conventional monetary policy framework
Although the PBoC does not officially define its policy framework, existing monetary policy
since the 1990s can be broadly defined as a mixture of quantity-based and price-based
instruments. It includes the main policy instruments that the market follows closely, such as
the required reserve ratio (RRR), deposit and lending rates, open market operation (OMO)
and loan quotas, as well as other instruments that are less closely followed– eg, FX
interventions, window guidance and administrative measures.
Interest rates
Like other central banks, the PBoC changes target interest rates. But unlike most central
banks in the developed world that control only the short-end of the curve (eg, the Fed fund
rates), the PBoC has tended to control all rates across maturities and type of rates – ie, both
lending and deposit rates. The central bank’s complete control over all rates has been mostly
relaxed when the lending rate floor was removed in July 2013.
In October 2004, the PBoC removed the upper limit of lending rates and the lower limit of
deposit rates, and in July 2013, the floors of the lending rates were removed, leaving the
ceiling in deposit rates as the only remainder from the era of regulated interest rates. In
general, the PBoC makes less frequent changes to the commercial bank benchmark deposit
and lending rates than to the RRR.
Fig 7 Deposit rate ceiling is the last remaining restriction
8
7
6
%
5
4
3
2
1
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
1-yr deposit rate
Nov-11
Nov-12
Nov-13
Nov-14
1-yr lending rate
Source: CEIC, Mizuho research
Require reserve ratio (RRR)
As a tool, the RRR is used much less in developed economies, but the PBoC actively
manipulate the RRR, arguably to adjust for changes in market liquidity in relation to foreign
capital outflows. Following massive capital inflows in recent years following the global
financial crisis, the general RRR has been near all-time highs at 20% since June 2012. In
April 2004, the PBoC changed RRR to a differentiated system in which banks with a belowstandard capital adequacy ratio must retain higher reserves. The system was further
diversified from April 2014 onward to direct lending to the real economy.
8
Economics Update
Fig 8 RRR diversified further in 2014
Required reserve ratio
23
21
19
%
17
15
13
11
9
7
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
Large financial institutions
Small and medium-sized financial institutions
Nov-11
Nov-12
Nov-13
Nov-14
Rural cooperatives
Rural commercial banks
Source: CEIC, Mizuho research
Open market operation
As a tool mainly to adjust short-term liquidity condition, China’s OMO began on a regular
basis in 2002 and is conducted in the form of central bank bills, repo and reverse repo; the
interest rate at which such instruments are sold has become guidance for market interest
rates.
Fig 9 OMO adjusts short-term liquidity condition
Open m arket operation
2,000
1,500
CNYb
1,000
500
0
-500
-1,000
Oct-11
Apr-12
Oct-12
Injection
Source: CEIC, Mizuho research
9
Apr-13
Withdrawal
Oct-13
Apr-14
Net change
Oct-14
Economics Update
Fig 10 The OMO became a tool for interest rate guidance
14-day repo rate
3.9
3.8
%
3.7
3.6
3.5
3.4
3.3
Feb-14
Apr-14
Jun-14
Aug-14
Oct-14
Source: CEIC, Mizuho research
Loan quota
Even though the PBoC has not imposed official quotas on commercial banks since the early
2000s, implicit loan quotas are often used as a complementary instrument by the central
bank to curb loan growth if the economy seems to be overheated, and vice versa.
Fig 11 Loan quota is no longer official but still closely followed
New loans
1,400
1,200
CNYb
1,000
800
600
400
200
0
Jan-14
Apr-14
Actual new loans
Jul-14
Oct-14
Target
Source: CEIC, Mizuho research
The PBoC prefers new targeted monetary instruments
On top of the aforementioned instruments, since January 2013 the PBoC has begun using
more innovative tools to manage monetary conditions in specific sectors. In its 3Q14
monetary policy report, the PBoC reiterated its preference for such tools and its willingness
to use them to maintain a generally accommodative monetary environment to stabilize
growth:
Standing lending facility
The PBoC first announced a trial program for standing lending facility (SLF) in January 2013
to provide flexible liquidity support. The SLF tends to have a short tenor of from 7-days to 3months, with liquidity provided by central and provincial branches of the PBoC, and usually
made available on the same day. It is a one-on-one arrangement between the central bank
and financial institutions to avoid excessive volatility in the money market.
10
Economics Update
The SLF accepts high-quality collateral such as government bonds, policy financial bonds,
and bonds from the China Development Bank. It differs from OMO in that the PBoC may
direct liquidity to specific target through primary dealers rather than to the entire market.
The medium-term lending facility (MLF) is similar and is design to guide medium-term
liquidity.
Fig 12 MLF injected nearly CNY770b over September and October
900
800
700
CNYb
600
500
400
300
200
100
0
Jul-13
Oct-13
Jan-14
Apr-14
SLF
Jul-14
Oct-14
MLF
Source: CEIC, Mizuho research
Pledged supplementary lending
Pledged supplementary lending (PSL) is another new instrument by which financial
institutions obtain collateralized loans from the PBoC with a mandate to relend to specific
sectors, in order to promote structural reforms. PSL interest rates are also used by the PBoC
as medium-term interest rate guidance. The tool resembles the central bank’s existing
relending facility, but the PBoC may use the collateral requirement to enforce relending
requirements.
Short-term liquidity
Short-term liquidity (SLO) is another supplementary instrument for the monetary policy
framework with tenors as short as 7-days and auctioned in an open setting. The SLO is more
similar to the conventional policy tools than the aforementioned new instruments described
above, as it does not require a one-on-one platform that lacks transparency. In fact, it can be
considered a short-term OMO that can occur more frequently and flexibly than the traditional
instrument.
In our view, however, targeted easing measures should not replace the conventional tools
such as interest rate cuts and RRR cuts, as they: 1) lack transparency and market
participation, against the policymakers’ previous emphasis on communicating with the
market; 2) are a step backward in China’s financial marketization. Following the steps
previously taken to liberalize China’s interest rates, the PBoC’s should focus on shifting to
price-based (interest rate) tools from quantity-based tools; 3) are a misuse of the PBoC’s
mechanisms as a lender of last resort during emergency situations; and 4) bypass regular
policymaking mechanism, and confuse the role of other government departments, such as
the Ministry of Finance and PBOC in (see The PBoC’s confused monetary policy, 28 May).
11
Economics Update
China’s adaptation to the new policy
framework: Outstanding issues
In our view, China must be more careful as it lays out its policy framework, as the country
and the US face different constraints. For example, QE in the US was the solution after the
failure regular policy tools and closely resembles direct government subsidies for investment
in the real economy.
In China, the PBoC has relied on quantitative tools to neutralize the massive impact on base
money from rising FX reserves. Fortunately, China has had a great opportunity in our view to
shift from quantity-based to price-based tools in the past two years, as: 1) pressure for
capital inflows has been reduced along with the removal of capital account and exchange
rate controls; and 2) the Third Plenum confirmed that interest rate liberalization would
accelerate. After the deregulation, China’s monetary policy has to become more marketoriented than the traditional controls on interest and RRR rates.
Fig 13 The pressure for capital inflow has been reduced
800
600
CNYb
400
200
0
-200
-400
-600
Sep-11
Mar-12
Sep-12
Position for FX purchase
Mar-13
Sep-13
Mar-14
Sep-14
FX purchase position - Trade surplus-FDI
Source: CEIC, Mizuho research
We believe that the priority for Chinese policymakers is to increase efficiency in its financial
market; and to establish a reliable term structure for interest rates with regard to liquidity
preference, risk premium and interest-rate guidance.
China’s new monetary policy framework not yet fully formed
For example, China continues to lack a benchmark interest rate despite the imminent
completion of interest rate liberalization. While SHIBOR has become a valuable reference in
in money markets, it is still a long way from becoming the market’s new benchmark. Similarly,
it is still a trial program in the medium-term loan market, although China has launched a
prime rate for commercial bank loans.
Generally, the market continues to lack a market-based replacement for the benchmark
lending and deposit rates, even though the deposit rate ceiling is the only remaining remnant
of the old regulated system.
12
Economics Update
Fig 14 Short-term SHIBOR still a long way from becoming China’s new benchmark
SHIBOR
15
13
11
%
9
7
5
3
1
Nov-11
May-12
Nov-12
Overnight
May-13
1-week
Nov-13
May-14
Nov-14
1-month
Source: CEIC, Mizuho research
The market for government bonds has been too small to provide a functional benchmark for
market reference. Senior fellow at the Chinese Academy of Social Sciences (CASS) Yu
Dongding proposed that the Ministry of Finance could issue government bond at different
tenor to raise funds from the banking sector. Then the PBoC could sell FX reserves with the
proceeds to buy back the bonds. Such a move could expand the Ministry of Finance’s
balance sheet and reduce the PBoC’s, and it could expand the government bond market with
little impact on the government’s fiscal status.
Without benchmark interest rates, formation of central bank’s guidance transmission
mechanism in interest rates is difficult. Generally, the PBoC’s policy rate affects interest rates
in the wholesale market (eg, interbank rates), which in turn will move retail interest rates in
credit markets (eg, loan prime rates), impacting on the real economy as the central bank
designed. In practice, however, SHIBOR has been unable to affect interest rates in the credit
retail market.
Fig 15 The loan prime rate started in October 2013 may one day become the market-based benchmark
Loan prime rate
5.78
5.77
5.76
%
5.75
5.74
5.73
5.72
5.71
5.70
Nov-13
Jan-14
Mar-14
May-14
Jul-14
1-yr loan prime rate
Source: CEIC, Mizuho research
13
Sep-14
Nov-14
Economics Update
Fig 16 Targeted measures have so far been ineffective in lowering market interest rates
16
9.0
14
8.5
12
8.0
7.5
7.0
8
6.5
6
6.0
4
5.5
2
5.0
0
4.5
-2
Sep-09
%
%
10
Sep-10
Sep-11
Effective rate
Sep-12
Sep-13
4.0
Sep-14
Weighted average lending rate (RHS)
Source: CEIC, Mizuho research
Fig 17 The most effective method of cutting mortgage rates is interest rate cuts
8.0
80
7.5
60
7.0
40
6.0
20
5.5
0
YoY%
%
6.5
5.0
-20
4.5
4.0
Sep-09
Sep-10
Sep-11
Mortgage rate
Sep-12
Sep-13
-40
Sep-14
Transaction (RHS)
Source: Wind, Mizuho research
Instead, interest rates in the retail market have had significant impact on the wholesale
interbank market rates, as the PBoC continues to influence the lower limit of lending rates. It
is evident to us that China’s interest rate liberalization remains incomplete, as policymakers
should leave credit-market pricing to the market. All in, the PBoC’s attempt to follow the
Fed’s example by giving medium-term interest-rate guidance is counterproductive to China’s
interest rate liberalization policy, in our view.
How does the PBoC provide medium-term interest rate guidance?
The PBoC faces two main problems as it attempts to provide medium-term interest-rate
guidance. First, how does the central bank ensure interest rates are reasonable, and second,
how can the PBoC produce the desirable impact on the market.
In our view, it is difficult for interest rates set by the authority to reflect the situation in the
market accurately. For example, the PBoC issued a CNY1t loan through PSL to the state-run
China Development Bank at an interest rate of 4.5%. Meanwhile, as noted above, the MLF
carried a 3-month tenor at an interest rate of 3.5%.
In our view, the above suggests that the PBoC expects 3.5-4.5% to be a reasonable range
for medium-term interest rates. We found that, however, the ongoing risk-free rate in the
market significantly exceeds this level. As of 2 November, the expected return on one-month
14
Economics Update
wealth management products was 4.78%, while the expected return for 3-month, 6-month
and 1-year products were 5.07%, 5.23%, and 5.39%, respectively. In 2014, only 0.03% of
wealth management products had a return below expectations.
As such, we believe the risk-free interest rate in the market should be close to 5% already.
The government’s 3.5-4.5% guidance; thus, it is impossible to follow at below the market’s
risk-free rate.
Fig 18 Wealth management product return is much higher than 3.5-4.5%
Wealth m anagement products expected return
7.0
6.5
6.0
%
5.5
5.0
4.5
4.0
3.5
3.0
Oct-11
Apr-12
1-yr
Oct-12
Apr-13
6-mth
Oct-13
Apr-14
Oct-14
1-mth
Source: CEIC, Mizuho research
Generally, the lack of transparency is also a problem in PSL and other new targeted
measures in China. Until the PBoC decided to disclose the injection through MLF in the
3Q14 monetary policy report, it has been the source of market rumors and confusion. We
find it difficult to understand how the PBoC really plans to use PSL or MLF to give interest
rate guidance in the new policy framework when it is operating in the dark.
Targeted measures the “second-best options” in monetary policy
In our view, targeted measures reflect the multiple objectives of the PBoC. Compared to its
foreign counterparts, who may focus on an inflation target, or have a clear mandate of steady
prices and maximum employment, the PBoC has six objectives: low inflation, reasonable
economic growth, employment creation, neutral balance of payment, financial stability and
structural reforms. Chairman Zhou noted that the PBoC’s approach is based on the relative
urgency and the significance of each objective to develop its optimal policy.
15
Economics Update
Fig 19 An objective of the PBoC is to maintain financial stability through reducing shadow banking
Total social financing
1,400
1,200
1,000
CNYb
800
600
400
200
0
RMB loan
Entrusted loan
Apr-14
May-14
Trust loan
Jun-14
BAN
Jul-14
Bond
Aug-14
Equity
Sep-14
Source: CEIC, Mizuho research
No need for targeted measures when injection can be done by conventional tools
Nevertheless, we maintain that the use of targeted measures is difficult to justify. As the
PBoC attempts to regulate the market liquidity level with targeted tools in response to capital
outflows as reflected in the position of foreign exchange purchase, we maintain it is more
reasonable to cut the RRR. The RRR had been raised to unprecedented levels to neutralize
the impact from capital inflow in the past.
We discussed the merits of general RRR cuts in Unleashing loan demand through policy
normalization (12 May), namely: 1) increased two-way capital flows along with falling FX
purchase position reduce the need to maintain a high RRR; 2) the monetary policy
framework should shift from quantity-based tools to price-based tools; 3) the current RRR at
20% is higher than optimal, leading to reduced effectiveness; and 4) China’s RRR is too high
by global standards.
Why does the PBoC not turn to conventional tools such as RRR? China’s monetary policy
has been a part of the greater blueprint of economic reform and development. As small- and
medium-sized enterprises (SMEs) face limited access to credit, state-owned enterprises
(SOEs) continue benefitting from cheap credit due to their advantage in the market despite
some being uncompetitive. Until structural problems such as these are resolved in China’s
economy, providing liquidity to SMEs may require massive general stimulus.
Fig 20 Bank loan growth limited by deposit slowdown
18
17
16
YoY%
15
14
13
12
11
10
9
8
Sep-11
Mar-12
Sep-12
RMB Loan
Source: CEIC, Mizuho research
16
Mar-13
Sep-13
RMB deposit
Mar-14
Sep-14
Economics Update
Should targeted measures be included in regular monetary policy framework?
The monetary policy framework in the West does not need to serve multiple targets, and the
timing of the extraordinary measures was closely tied to the global financial crisis. Central
banks are not obliged to cater to specific policy interests. For example, the Funding and
Lending Scheme (FLS) by the Bank of England was open to all the banks and building
societies who wished to borrow UK Treasury Bills in exchange for eligible collateral, which
consists of all collateral eligible in the Bank’s Discount Window Facility.
In comparison, the PSL in China was done at a fixed price with fixed counterparts. The
results of these measures, in our view, tend to be economically inefficient and deviate from
the government’s original intent. In fact, several media reports suggest that loans targeted at
SMEs have gone to property developers. Administrative measures are difficult to complete
with profit motives in the market, and we believe it is unrealistic to expect targeted measures
to remain localized in the market.
As such, the targeted measures are at best “second-best” options among available policy
tools but could at best be used as a transitional measure. We also believe the PBoC should
not try to copy from the central banks in the west, as China remains at a different stage of
development with special considerations, such as the need for thorough structural reforms.
PBoC’s optimal strategy in policymaking:
The outlook
In fact, the PBoC has expressed concerns about targeted measures in its 2Q14 monetary
policy report when it suggested that China’s monetary policy would rely mainly on general
tools with targeted tools as short-term supplements. The report also acknowledged that longterm use of the targeted measures could be problematic. As China’s interest-rate
liberalization approaches the final stage, the new measures could jeopardize progress in
structural reforms.
Clarify the objective of monetary policy
In our view, the PBoC should work on increasing its independence and lower its expectation
of pushing through structural reforms by monetary policy. Meanwhile, the reforms on fiscal
budgeting, taxes, SOE and administrative structure need to accelerate. We also think the
PBoC should focus on increasing the effectiveness of monetary policy, such as by increasing
communication with the market, and improving market disclosure.
Improve communication with the market
The PBoC should also hold regular press conferences to address market concerns and
provide clear and timely responses. So far, the PBoC has relied on its website and press
releases to relay its policy intentions, and the policy direction it conveyed to the market has
been confusing at best (see China’s imprudent "prudent" monetary policy 7 August 2013).
However, as in the press release of the PBoC monetary policy committee regular meetings
shows, there is currently little useful information available for the market.
17
Economics Update
Fig 21 China’s economic policy has generally lacked transparency
Fiscal
Monetary
Focus
2014
Proactive
Prudent
Push for China’s structural adjustments, support growth through reform and innovation
2013
Proactive
Prudent
Balance between maintain growth, adjust structure, promote reform and prevent risk
2012
Proactive
Prudent
Promote social development and progress while maintaining stability
2011
Proactive
Prudent
Maintain relatively rapid economic growth
2010
Proactive
Moderate easing
Maintain continuity and stability of economic policy
2009
Proactive
Moderate easing
Expand domestic demand to maintain relatively rapid growth
2008
Prudent
Tight
Control growth, stabilize price, adjust structure, promote balance
2007
Prudent
Prudent
Push for rapid and good economic development
2006
Prudent
Prudent
Continue to enforce economic consolidation
2005
Prudent
Prudent
Reinforce the result of economic consolidation
2004
Proactive
Prudent
Maintain continuity and stability of economic policy
2003
Proactive
Prudent
Improve speed, structure, quality and efficiency
2002
Proactive
Prudent
Expand domestic demand to improve growth quality
2001
Proactive
Prudent
Use various macro tools to reinforce economic growth
2000
Proactive
Prudent
Focus on SOE reform
Source: Mizuho research
Also, the PBoC should reveal its expectations on economic trends and inflation. Although a
part of its quarterly monetary policy report is devoted to this, the information is too board to
offer any concrete advice to the market. Instead of repeating familiar rhetoric such as
“reasonable economic growth”, “steady financial conditions”, and “generally stable inflation”,
the PBoC can communicate its assessment of the market more concretely.
Priority on interest rate liberalization
All in, we believe the PBoC’s priorities should be to push for interest-rate liberalization,
further develop financial markets and establish a reliable term structure for interest rates
regarding liquidity preference based on market forces. Meanwhile, the development of a new
monetary policy framework should proceed with care, and have greater reference to the cost
and benefit of the international models.
18
Economics Update
16 October 2014
Three new cases of shadow-banking risk
China’s financial system is under strain recently, due not only to monetary policy, but also
from the legacy of rapid debt expansion in the past 5 years, in both the official banking
system and the shadow banking sector. In the past few weeks, three cases of financial
vulnerability draw our attention. We believe these represent a general rising risk in the
financial system under a slowing economy.
 Case 1: On 12 Sep, Chinese media (the People’s Net) reported that Evergrowing Bank,
a Shandong based joint stock commercial bank had compensated two Tianjin
commercial banks with CNY4b for a default loan it guaranteed through a series of interbank transactions. Such transactions allowed Chengdu Mind Group (CMG), the major
shareholder of Evergrowing Bank to obtain CNY3.7b of credit through the three banks’
off-balance sheet lending in Aug 2013. The media reported that the transaction did not
go through the internal approval process, but instead was conducted directly under the
instruction of the bank’s chairman.
 Case 2: On 23 Sep, Sino Steel Corporation acknowledged a failure to meet its liability
on time; according to public data, the company’s total debt had reached CNY103b by
end-2013.
 Case 3: On the same day, the media reported that the owner of the largest property
developer in Handan City ran away with the company’s cash, which triggered a
CNY9.3b debt crisis and a domino effect in the city’s underground lending market.
Our main concern with these cases could be the beginning of a series of similar
incidences to come. Implicit guarantees introduce a significant moral hazard problem
within the shadow banking system, while the deceleration of growth and the slowdown of
property sales would expose non-performing loans (NPL), impacting the stability of the
entire financial sector.
These cases also reveal that corporate governance and internal control problems exist in
the Chinese banking sector. Furthermore, as China gradually allows private capital to
enter the banking industry, corporate governance issues between a privately owned bank
and its shareholders represent a new challenge to regulators.
In order to tackle this rising risk, further consolidation of the shadow-banking sector is
necessary. Since 2014, the government has gradually established a regulatory framework
for the whole shadow banking system. Regulatory arbitrage is reduced. Moreover, a
solution to address the local government debt issue, which is closely related to the
shadow banking system, was offered by the government with additional details coming out
over the past a few months.
In our view, the government appears to be prepared to break the implicit guarantee in the
near future. To mitigate the hard landing risk for the economy, we also expect more
easing measures to be adopted. These measures will concentrate on the relaxation of
housing purchase restrictions, reducing mortgage rates, and promoting housing demand.
19
Economics Update
Case 1: Bailing out a default by a bank
The shadow banking system: both as a lender and a guarantor
Borrower and lenders
In August 2013, Chengdu Mind Group (CMG) obtained a CNY3.7b loan through a series of
complicated transactions. These transactions include a trust, an asset management product,
and a trust loan, backed by another asset management product. A trust company and two
securities houses helped to set up the financing arrangement while China Merchant Bank
and Industrial Bank served as bridges in the trust loan transaction. Nominally, Jinan branch
at Bank of Tianjing and Tianjing Binhai Rural Commercial bank (TBRC) invested CNY3.7b
and obtained the ownership of these arrangements.
In fact, Evergrowing Bank initiated all these transactions and acted as both lender and
insurer. The bank deposited a CYN2.5b inter-bank loan at TBRC just one day before the loan
was issued. Funds from the deposit were widely believed to be used in the CMG loan.
Moreover, Evergrowing Bank signed a repurchase agreement with Bank of Tianjin and TBRC
that Evergrowing Bank would honour the loan in the case of default by the borrower. This
deal represents a typical case of shadow banking system activities in China.
Getting around the regulations
With the guarantee from Evergrowing Bank, Bank of Tianjin and TBRC treated the deal as
investing in an asset with repurchase agreements, and therefore did not need to comply with
the capital and LDR requirements. Nevertheless, even Evergrowing Bank took actual default
risk on the book, the bank only made a risk-free inter-bank deposit. The bank managed to
bypass the capital and LDR regulations.
The bailout began
On 29 Aug 2014, Evergrowing Bank purchased the ownership of the trust and the asset
management product from Bank of Tianjin and TBRC with CNY4b, including both CNY3.7b
in principal and CNY300m in interest. According to state-owned media Renming Net, a team
from Evergrowing Bank is now working at CMG to secure the company’s assets and monitor
the cash flow of its property business. An Evergrowing bank staff with knowledge of the
situation told the press “as the bank acted quite fast, risk is still manageable.”
The connection between CMG and Evergrowing bank
According to CMG’s official website, the company’s business involves real estate,
agriculture, financial leasing, and private equity investment. Although CMG released an
officially statement noting that both the company’s borrowing from the trust and asset
management schemes and Evergrowing Bank’s acquisition of the ownership of such
schemes were “normal business”, Renming Net suggested Evergrowing Bank’s current
management was not aware of this transaction, which did not go through the normal internal
approval process. In addition, CMG acknowledged that the group holds 3.28% of
Evergrowing Bank’s shares.
20
Economics Update
Fig 22 Structure of the Evergrowing Bank and CMG deal
Evergrowing Bank
CNY 2.5 bn
inter-bank deposit
Ownership of an asset
management theme
under the table
guarantees/repurchase
agreements
Bank of Tianjin
Holding 3.28% of
the bank’s share
TRCB
Donghai
Securities &
Sino-Australian
Trust
CNY 2.7 bn
loan was provided
CNY 1.0 bn
investment
China
Merchant
Bank
(3968 HK)
CNY 2.7 bn investment
60% stock beneficial right of two
subsidiaries of CMG
60% stock
beneficial right of two
subsidiaries of CMG
Chengdu Mind Group (CMG)
Industrial Bank
(601166 CN)
CNY 1.0 bn
entrust loan
Source: Mizuho research
21
CNY 1.0 bn
investment
CNY 1.0 bn
entrust loan
Ownership
of an asset
management
theme
Great Wall
Securities
Economics Update
Box 1： How interbank activities become part of shadow banking
Interbank activities are defined as the financial transactions between commercial bankers
and transactions between commercial banks and other financial institutions. Such activities
include mainly interbank lending, placements, and repurchases.
The interbank market in China has undergone rapid development in recent years and has
had a significant impact on the country’s total money supply. In the past, money-supply
growth mainly came from domestic loans and FX purchases. When commercial banks issue
loans or make an FX purchases, the asset increase would be matched with an identical
increase in renminbi deposits, leading to money creation through money multiplier.
However, recent innovations in interbank activities have led to a new channel for money
creation – ie, interbank loan extensions from commercial banks to non-banking financial
institutions, such as asset management firms and insurance companies. According to Wu
Xiaoling, deputy director of the Financial and Economic Affairs Committee at the National
People’s Congress, such loans generate additional money supply at higher financial
leverage. Since 2013, such interbank loans have exceeded FX growth, becoming the second
largest M2 source following renminbi loans. The interbank market also led to increased
volatility in M2 growth in 2013.
Fig 23 Medium-to-small sized domestic banks became active lenders in 2013
(CNYb)
Repurchase market
Interbank lending
3Q13
3Q12
3Q13
3Q12
-34160.6
-43446.1
-2958.4
-6047.0
Medium to small domestic
banks
11422.0
21118.9
-2215.9
828.7
Securities and funds
11544.5
9283.7
3067.9
2689.2
Insurance companies
4407.3
3732.0
--
--
Foreign financial institutions
1195.0
1450.7
434.0
676.8
Other financial institutions
and products
5591.8
7860.8
1672.3
1852.3
Large domestic banks
Source: PBOC, Mizuho research
(See 10 questions on China’s shadow banking, 9 January).
22
Economics Update
Case 2: The default of Sino Steel
Another default case attracting investors’ attention involves Sino Steel Group. From the
evening of 22 September, there was talk among bankers that Sino Steel Group, a central
SOE, had not paid back its loan on time. It was rumoured that the total scale of default loans
would reach several tens of billions of yuan; ICBC, Bank of Communications, as well as
some other banks were involved.
On 23 September, the company’s speaker acknowledged to the media, “some defaults did
happen”; however, he declared that the rumoured amount of the default was “far from the
reality”. He also stated, “The company is still operating in a normal way”. Moreover, ICBC
denied the bank has had any loan default from Sino Steel Group as well.
It is still unknown at this moment how the issue will be addressed, but it is unlikely that the
company will go bankrupt. Some talk in the market says that the government would inject
some capital into the company and that it had coordinated with the banks to forgive or extend
some loans.
Sino Steel is a heavily indebted corporation
Although the scale of default is smaller than expected, it is clear that Sino Steel Group has
struggled for years. The group’s debt to asset ratio has exceeded 90% since 2009. In 2013,
the group’s revenue reached CNY140b, but net profit was only CNY135m. Moreover, total
liability of the group reached CNY103.3b by end-2013.
Fig 24 Debt and debt to asset ratio of Sino Steel Group
140
100
120
95
100
80
90
60
85
40
80
20
0
75
2007
2008
2009
Total Debt
2010
2011
2012
2013
Debt to Asset Ratio （RHS)
Source: China Chengxin Credit International, website of Sino Steel Group, Mizuho research
The group’s cash flow can be particularly vulnerable due to high short-term debt and high
inventory, prepayments and receivables. The company’s major assets belong to Sino Steel
Corporation, a subsidiary of the Group. By the end of 2013, Sino Steel Corporation had
CNY59.4b in short-term debt, accounting for 83% of the company’s total liability. Meanwhile,
inventory, account receivables, and prepayments reached CNY45.5b. As the economy slows,
clients and steel traders of both the group and the subsidiary may not be able to meet their
obligations. In such a case, it is possible that the group could suffer more losses and default
again in the future.
23
Economics Update
Case 3: Handan’s default on underground
lending for housing
Handan, a city with 1.6m people in Hebei province, is the now the centre of an underground
lending default storm, according to a report by 21 Century Economic Herald on 23
September.
Golden Century Property triggered the domino effect. The company is a leading local
property developer, which started to borrow from the underground market in 2006 to finance
projects. The company promised to pay individual lenders rates of 30% and above to attract
investors. When the property market was booming, investors saw very good returns.
However, as the property market started to cool down since 2012, the company’s cash flows
became increasingly problematic. Two months ago, the chairman of the company suddenly
“disappeared”, leaving many investors unpaid.
Many other property developers followed Golden Century Property’s lead and raised money
from individual investors by also offering high returns. After Colden Century Property
defaulted, a few other companies also stopped payments to investors. According to the
Handan Committee of Addressing Illegal Financial Activities, a special government entity set
up to deal with this issue, the total scale of underground lending had reached CNY9.3b and
22.7% of local property developers are involved.
The property market in Handan is now in flux. Both sales and construction of many property
projects have been suspended and even potential buyers have stopped purchasing,
concerned that developers may run off with their money.
Fig 25 Property sales in Handan
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
2003
2004
2005
2006
Property sales in sum (CNY m)
2007
2008
2009
2010
2011
2012
2013
Property sales in area (thousand square meter)
Source: CEIC, Mizuho research
Box 2: Underground lending in China
Underground lending: definition, function, and risk
Underground lending refers to lending made directly by companies and individuals.
Chinese law prohibits lending between non-financial institutions, but individuals are
allowed to lend to a corporate or another individual. In 1991, the Chinese Supreme Court
ruled that lending rates higher than 4 times of PBoC’s policy lending rate would not be
guaranteed; thereby, setting a ceiling for this underground lending market.
Underground lending started as early as 1980s. SMEs and individuals unable to access
24
Economics Update
bank credit often resort to this market to finance projects and investments. In practice,
enterprises may lend to one another as well as breach the interest ceiling. In such cases,
transactions only happen between people who trust each other because if the borrower
cannot repay the loan, lenders have no legal protection.
Underground lending plays a complimentary role for the official financial system. But it
involves major risks to the shadow-banking system, such as maturity mismatches and
credit transfer. Some enterprises resort to underground lending for bridge loans, but such
behaviour distorts information in the official banking sector. In addition, channelling loans
from banks to the underground lending market increases credit risk in the banking system.
Setting up micro credit companies reduces the size of underground lending market
To improve transparency and better regulate the underground lending market, the China
Banking Regulatory Commission (CBRC) and PBoC allowed private capital to establish
micro-credit companies in 2008. Such corporations could use their own capital and borrow
less than 50% of their net capital from banks to lend to borrowers, which turns
underground lending into formal financial transactions. By June 2014, total outstanding
loan of micro credit companies reached CNY 840 b.
Fig 26 Growth of micro credit corporations in China
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
2009
2010
2011
No. of micro credit corporations
2012
2013
1H2014
Loan outstanding (CNY b)
Source: PBoC, Mizuho research
Still, some private lending happens unregulated. PBoC‘s survey shows that such lending
reached CNY3.38t by May 2011. According to South-western University of Finance and
Economics, underground lending grew to CNY5.28t by the end of 2013. Accounting for
only 7% of total CNY loans, we do not expect underground lending to pose systematic risk
to the economy, but disruption to local economies and local property markets is possible.
Regulators are considering to liberalize the underground lending market and to improve its
transparency further. Wenzhou Private Lending Rule, the first regulation governing the
market in China, took effect on March 2014. The rule allows nonfinancial corporations to
provide short-term loan (less than 3 months) in Wenzhou. Wenzhou municipal government
also encourage borrowers and lenders to register their deals. According to the media, the
proposed new General provisions of Lending Law may legalize lending between
enterprises and raise the interest rate ceiling set by the Chinese Supreme Court.
25
Economics Update
Revealing the risks in the financial system
Exposing the risks of corporate governance
Evergrowing Bank’s risk exposure shows how banks’ corporate governance and internal
auditing can be relatively weak when involved in shadow banking business. Off-balance
sheet activities are more difficult to monitor, as actual liability is usually hidden and
transactions are often complicated. Similar cases have occurred in the past, such as Bank of
Yantai’s CNY436m bill case in 2011 and Qilu Bank’s fraud bank acceptance bill case in 2012.
Corporate governance problems exist in the banking sector and could occur again in the
future.
However, corporate governance risk may still be manageable at this moment. From the
bank’s perspective, Evergrowing Bank’s total assets reached CNY800b, with over CNY32b in
net equity by end-2013. Even if CNY4b were completely lost, we believe it would not threat
the bank’s survival.
Fig 27 Scale of Evergrowing Bank‘s asset and capital adequacy ratio (CAR)
90
14
80
12
70
10
60
50
8
40
6
30
4
20
2
10
0
0
2008
2009
2010
2011
Total Asset (CNY b)
2012
2013
CAR (RHS %)
Source: Annul Reports of Evergrowing Bank, Mizuho research
From the sector’s perspective, there is no evidence that suggests that insufficient internal
control is a widespread phenomenon in China. Previous cases have all been addressed on a
case-by-case basis by the regulators. So, Evergrowing Bank’s case should not be an
exception.
Risks of opening the banking sector to private capital
The case of Evergrowing Bank reminds us of another type of risk: privately owned banks
may become cashiers of their shareholders in the future. Currently, most banks in China are
state owned and their management teams are directly appointed by the government. Even in
such a situation, it seems that Evergrowing Bank lent money to its shareholder under lessthan-rigorous standards. As China gradually allows private capital to set up new banks,
corporate governance issues between a privately owned bank and its shareholders could
pose a new challenge to the regulators. In Taiwan’s example, after Taiwan opened its
banking sector to private capital in the early 1990s, many banks lent public money to their
owners to finance “zombie projects”. It eventually led to a banking crisis in 1997.
Risks of the shadow banking system
What concerns us most is the risk of the shadow banking system. The Evergrowing Bank
deal exposes the major risks of the shadow banking system. Broadly speaking, shadow
banking in China refers to the entire financial intermediary system outside of the traditional
26
Economics Update
banking sector, involving trusts, wealth management products (WMP). Shadow banking in
China is a different concept from its western counterpart, as it involves relatively few complex
financial innovations such as asset securitization and financial products. Nevertheless, some
shadow banking activities in China are potentially destabilizing due to maturity mismatching,
liquidity risk, credit risk and high leverage.
In the Evergrowing Bank deal, term transition and liquidity transition was accomplished as
the three banks supported CMG’s long-term projects with short-term deposits. The
repurchase agreement let two Tianjin commercial banks transfer credit risk to Evergrowing
Bank. As Evergrowing Bank took de facto credit risk without allocating more capital, the
bank’s financial leverage increased. The three banks also injected credit into property sector,
a relatively high-risk sector that the regulators and policy makers want to cool down.
Implicit guarantee, despite the lack of supervision
The worst regulatory arbitrage of the Evergrowing Bank incident is the implicit guarantee of
repayment. Evergrowing Bank eventually repurchased ownership of the default trust/asset
management schemes with full compensation. Given that the state effectively backs every
bank registered in China, the government actually guaranteed all these activities, but it did
not supervise them, as all banks managed to avoid LDR, capital and other regulations.
The above analysis applies to other shadow banking activities and products such as WMPs
and collective trust products. This type of behaviour obstructs China’s economic structural
reforms and escalates the risk of financial instability, in our view. According to our estimates,
the total scale of the shadow banking system in China has reached CNY33.9t by 2Q14.
Hence, risk need to be closely monitored.
Fig 28 Size of the Chinese shadow banking system
Shadow banking
35
60
30
50
25
40
CNYt
30
15
20
10
10
5
0
0
2010
2011
2012
Shadow banking
% of GDP (RHS)
Source: Mizuho research
27
2013
(%)
20
Economics Update
Box 3: The definition and size of China’s shadow banking
Until now, little official effort has been made to define China’s shadow banking. Document 107, released by the
State Council, does not define shadow-banking activities but classifies them into three categories:
 Unlicensed and unregulated credit intermediation – eg, online financing companies
 Unlicensed but nominally regulated credit intermediation – eg, credit-guarantee companies and microcredit companies
 Licensed but insufficiently regulated financing activities – eg, money-market funds, informal asset
securitization, and some wealth management businesses
Broadly speaking, shadow banking is the entire financial intermediary system outside of the traditional banking
sector; it involves trusts, entrusted loans, and wealth management products. Such innovations do not necessary
have an adverse effect on the stability and healthy development of financial markets.
 China’s shadow banking is different from its western counterparts, as the former involves relatively few
complex financial innovations such as asset securitization and financial products. Nevertheless, some
shadow-banking activities in China are potentially destabilizing due to maturity mismatches, liquidity
risks, credit risks, and high leverage. We believe that the government intends to scrutinize activities
that are mainly related to licensed but insufficiently regulated financing activities – eg, trust products,
money market funds, interbank lending, and some wealth management businesses
Fig 29 Shadow-banking activities
Activities regulated by CBRC, Semi-financial activities
CIRC, and CSRC
regulated by local
governments
Unregulated activities
New financial market
innovations
Banking, wealth management
Pawn shops
Online financing companies
Asset securitization
Trust companies
Guarantee companies
Informal lending
Margin and repo activities
Securities firms
Leasing companies
Third-party lending
FX funds
Fixed income products
Private equity
Funds
Micro-credits
Insurance
Financial corporate activities
Source: CBRC, Mizuho research
Estimating the size of shadow banking
A starting point for estimating the size of China’s shadow-banking system is total social financing, created by the
People’s Bank of China (PBoC) to capture recent developments in China’s financial system. In addition to bank
loans, total social financing also consists of FX loans, trust loans, entrusted loans, bankers’ acceptance notes, and
direct financing. Thus, in 2013, total social financing (excluding bank loans) expanded by more than 3.5x.
However, total social financing does not effectively capture the idea of shadow-banking system, which is defined
as financial intermediaries involved in credit creation. According to the Chinese Academy of Social Sciences
(CASS), the scope of shadow banking could range from wealth management and trust companies (the narrowest
definition) to include non-bank financial institutions such as leasing and financing companies, interbank activities,
micro-credit companies, guarantee companies, pawnshops, and entrusted loans. At its broadest definition, shadow
banking would also include online, third-party, and informal lending. According to CASS, the shadow-banking
system in China was between CNY14.6t and CNY20.5t in 2012 and equivalent to 29–40% of GDP.
We adopt the broader definition in our estimate of shadow banking system. Following rapid expansion of the
system in 2013, we expect shadow banking in China to have expanded to CNY29.9t. However, it is important to
note that only some of the shadow-banking instruments are risky due to maturity mismatch, liquidity risk, credit
risk, and high leverage. This is the area that the State Council’s Document 107 focuses on for more targeted
control.
Rapid development of the shadow-banking system
In addition to its size, in recent years the market has often been concerned about the rapid expansion of the
28
Economics Update
shadow banking system. China’s shadow-banking system came into being after the government’s CNY4t stimulus
package in 2009. In 2010, the size of trust market was around CNY1t.
Favorable conditions for the development of shadow banking include: 1) Interest-rate restrictions and heavy
regulations on banking practices, which were created as an incentive for banks to promote off-balance sheet
activities; 2) Ample liquidity from the government stimulus package, capital inflows, and high domestic savings; 3)
Land monetization; 4) Strong demand for financing from local governments; 5) Capital needs from property
developers; and 6) Rapid development of the interbank bond market and support for financial innovation
Fig 30 Estimating the size of China’s shadow banking system
Size in 3Q13 (CNYb)
72,000
4,700
8,000
4,600
6,500
9,100
2,900
8,500
7,000
2,700
610
Renminbi loans
FX loans
Entrusted loans
Trust loans
Bankers’ acceptance notes
Corporate bonds
Securities
Trust asset management
Interbank activities
Bank-securities activities
Micro-credit
Total
Our definition






29,910
Source: CBRC, Mizuho research
Risk of default
Although only occasionally does a bank provide loans without going through the internal
approval process, these cases – the default of CMG and its property business, Sino Steel
Group’s failure to meet its obligation and the bust of the underground lending system in
Handan – did not simply occur by accident. We believe this is just the tip of the iceberg of
the extent of the degree of credit default that is emerging in China.
A significant amount of resources have been misallocated since the “CNY4t stimulus
package” of 2009 – from wasted infrastructure, houses laying empty since being constructed
to industries with overcapacity. When the economy slows down, the number of default cases
will go up. According to the CBRC, 2Q 2014 is the 11th consecutive quarter that official NPLs
in China’s banking system have continued to rise, and it is likely this trend will continue.
When defaults occur in large scale, the stability of the financial system may be affected.
Fig 31 NPLs of the Chinese banking system
800
700
600
500
400
300
200
100
NPL (CNY b)
Source: CBRC, Mizuho research
29
Jun-14
Mar-14
Dec-13
Sep-13
Jun-13
Mar-13
Dec-12
Sep-12
Jun-12
Mar-12
Dec-11
Sep-11
Jun-11
Mar-11
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Jun-09
Sep-09
Mar-09
0
Economics Update
Policy response 1: New regulations
disciplined the shadow banking system
We do not believe Evergrowing Bank’s under-the-table repurchase agreement – a common
interbank-activity practice of banks before 2014 – will reappear on a large scale again.
Regulators have been addressing regulatory arbitrages. Not only is the official banking
system gradually delinking from shadow-banking risks, but also other shadow-banking
institutions are being disciplined.
A regulatory framework gradually being established
Document 107, published by the State Council in January 2014, lays a foundation for
regulating the entire shadow-banking system. The regulation clearly defines the scope of
China’s shadow-banking system and assigns major shadow-banking activities to specific
regulators. Financial institutions are prohibited from taking risks if corresponding provisioning
or capital is not allocated.
Examining under-the- table repurchase agreements, we found that Document 107 requires
relevant financial institutions to have an binding contract. The contract must clarify who takes
risks and who only serves as a channel. The regulators of risk-taking parties will put such
transaction into existing regulatory framework. Banks cannot avoid capital and LDR
requirements; consequently, the incentive to conduct such transactions is significantly
reduced.
In fact, many ministry-level regulations on the shadow banking systems were enacted in
2013 and 2014. For example, CBRC Document 8 in 2013 defined the scope that WMPs can
invest; CBRC Document 99 in 2014 provided detailed guidance on how trust firms should
comply with the state council’s Document 107.
Fig 32 Major regulations supervising shadow banking system in China since 2013
Date
Regulator
Mar-13
CBRC
Contents
Specified the maximum amount of non-standard asset he held by financial
institutions and their WMPs
May-13
SAFE
Restricted cross border financing activities through letter of credit
May-13
CBRC
Regulated the illegal trading of Bankers' acceptance bill through rural financial
institutions
Nov-13
CBRC
Intensified scrutiny of interbank financing
Jan-14
State Council
May-14
PBoC
Disciplined banks’ interbank holdings and fixed major loop holes of the interbank
activities
Apr-14
CBRC
Raised standard of trust companies' capital requirement and offered detailed
guidance on how trust firms should comply with Document 107
Defined and putting the whole shadow banking system under a regulatory
framework
Source: CBRC, PBOC, SAFE, State Council, Mizuho research
Regulations started to discipline the shadow banking system
After such regulations and Document 107 took effect, banks and the official financial system
is gradually separated from the shadow banking risks.
From banks’ perspective, the growth of buy/sell back assets of 16 listed banks in A-share
slows down since 2Q13. It is well known that such asset is mostly created by shadow
banking related interbank activities. The transaction conducted by Evergrowing bank is a
typical case.
30
Economics Update
Fig 33 Growth of buy/sell back assets of all 16 banks listed in A-share
60%
50%
40%
30%
20%
10%
2Q2014
1Q2014
4Q2013
3Q2013
2Q2013
1Q2013
4Q2012
3Q2012
2Q2012
1Q2012
4Q2011
3Q2011
-10%
2Q2011
0%
-20%
Source: Wind, Mizuho research
From the perspective of the banks’ partners, data shows that asset management cooperation
between bank and trusts declined significantly in 2014. A similar trend occurred with asset
management between banks-securities companies. The growth rate for AUM at securities
companies declined to 75.4% in 1H14 from 175.1% in 2013 according to Securities
Association of China.
Fig 34 Scale and growth of trust assets
14
120%
12
100%
10
80%
8
60%
6
40%
4
20%
2
0%
Trust-bank cooperation (CNY t)
Growth of trsut asset
Jun14
Mar14
Dec13
Sep13
Jun13
Mar13
Dec12
Sep12
Jun12
Mar12
Dec11
Jun11
Others (CNY t)
Sep11
-20%
Jun14
Dec13
Jun13
Dec12
Jun12
Dec11
Jun11
Dec10
Jun10
0
Growth of trust-bank cooperation
Source：China Trust Association，Mizuho Securities
Other shadow banking institutions are disciplined as well. Our contacts at trust firms told us
that their “cash pool” business is gradually shutting down this year.
Tightening shadow-banking credit would lead to higher default risk
Of course, regulating shadow banking business will let hidden problems emerge. As shadow
banking is disciplined, it is more difficult for vulnerable enterprises and property developers
to mange their cash flows. Together with a slower GDP growth, stricter shadow banking
regulation would lead to a higher default rates in the Chinese financial system. The three
default cases described in the piece represent such trend.
Furthermore, an important part of these new regulations is clarifying financial institutions’
benefits and responsibility in the shadow banking system. Shadow banking essentially
belongs to direct finance, i.e. investors rather than financial intermediate need to take both
gains and loss. When default happens, enforcement of new regulations will directly challenge
the implicit guarantees.
31
Economics Update
Box 4: Who controls the risks in shadow banking?
Identifying risks for effective regulation
Document 107 aims at clearly defining China’s shadow-banking system, identify risks, and
proposing specific, effective measures to supervise such activities "one by one," with proper
internal controls and risk-management systems. Essentially, the document aims at: 1)
ensuring that financial institutions are liable for the risks generated in their business; 2)
establishing sophisticated management systems to improve risk management and internal
controls; 3) preventing excessive financial leveraging and collusive practices; and 4)
restricting non-financial institutions from conducting leveraged financial activities outside
their original business scope. In particular, these include:
 Trust companies – the biggest non-bank players in the shadow banking system –
should return to their original function as asset managers rather than engaging in
“credit-type” businesses
 A ban on using third parties evading restrictions on lending directly to certain
borrowers
 An order for banks to establish separate units for their wealth-management
businesses, and to create provisions and set aside capital for them
 A ban on banks using WMP-funded by customer savings to buy loans from the
bank’s balance sheet
 A ban on trusts from pooling deposits from more than one product and investing
them in non-tradable assets
 A ban on pawnshops issuing debt and increasing financial leverage
 Bans on micro-credit companies from taking deposits, issuing loans at exorbitant
rates, and illegally collecting loans
Shared responsibilities between all regulators
In Document 107, the State Council seeks to address the problem of banks exploiting
loopholes by clarifying the responsibilities of various regulators, including the PBoC, the
CBRC, the China Insurance Regulatory Commission (CIRC), and the China Securities
Regulatory Commission (CSRC). The document asked for more frequent inspection and
investigation that is more thorough to keep risks under control. The document also proposes
delegating the power of monitoring other activities to the local governments to ensure
effective supervision.
As a result, the CBRC also announced on 6 January that in 2014 it would aim at reducing
banking-sector risk by 1) controlling total loans, differentiating risks, and reducing individual
risks; 2) controlling risk from property loans by examining the liquidity adequacy of selected
enterprises; 3) reducing excess capacity through restructuring and promoting effective use of
production facilities; 4) managing wealth management and trust businesses to avoid pooled
purchase and excess leveraging; 5) improving interbank, wealth management, and
investment management to enhance capital stability; 6) avoiding risks coming from
information systems; and 7) strictly enforcing all applicable laws in the banking sector.
Meanwhile, the National Development and Reform Commission (NDRC) also released
guidelines for bond issuance in 2014. In particular, it stated that high-yield LGFV bonds
backed by urban infrastructure would be allowed to reissue as long-term low interest debts.
In December 2012, over half of LGFV bond carried interest rates above 8.2%. Meanwhile,
the NDRC will also promote better social housing by allowing “bond/loan” combination by
banks for sustainable management and consolidate bonds issued by industries burdened
with excess capacity.
32
Economics Update
Policy response 2: Allowing implicit
guarantees to be broken
We expect the regulators to allow implicit guarantees to be broken and to discipline the
market in the forthcoming months; however, those cases will be selected to minimize their
impact to the economy.
As we discussed previously, implicit guarantee introduces a significant moral hazard problem.
It encourages investors to participate in more risk-taking activities with the misconception
that the government will eventually bail them out. (See A bailout – Chinese style, 28 January).
Resource allocation is significantly distorted in the Chinese financial market.
However, breaking the guarantee is not that easy. When information disclosure is poor, and
when investors are not educated sufficiently to evaluate risk and return, default can easily
lead to a collapse of the system, due to adverse selection. George A. Akerlof, a Nobel
Laureate in Economics, made solid arguments in his famous “lemon market” theory. But
without defaults, there is very little incentive for borrowers to improve information disclosure
and for investors to enhance their skills to evaluate risk. The government is in a dilemma.
We argued that the government needs to focus on fiscal reform and to change the role of
government to correct market distortion. (See Trust product default risk: dilemmas and
implications, 22 Jan 2014) Eventually, implicit guarantees must be removed. We have seen
some positive steps recently.
Addressing Local government debt issues
Fiscal reform makes debt rollover at LGFV feasible, reducing the size of implicit
guarantee issue: According to the National Auditing Office (NAO), most funds raised by
local governments were used for infrastructure building and other public services.
Consequently, borrowing of Local Government Financing Vehicle (LGFVs) is more a maturity
mismatch problem than a solvency problem. The NDRC therefore allows LGFVs to issue
long-term bonds to replace short-term loans from banks and the shadow banking system. Dr
Ba Susong, a senior researcher at the Development and Research Centre of the state
council, estimated that 2Q14 and 3Q14 was a peak season for LGFVs to repay debts, but
neither Dr Ba nor we have seen any default of LGFVs.
Fig 35 Expenditure of local government debt
Enviroment Industrials
1%
protection
3%
Intrastructure agriculture
4%
Science,education,
culture & health
5%
Others
12%
Urban construction
37%
Afforadble housing
7%
Infrastructuretransportation
14%
Source: NAO, Mizuho research
33
Land reserve
17%
Economics Update
Debt rollover is feasible also because the problem is not simply postponed. The new Budget
Law requires local governments to include all their revenues and expenditures into their
budgets. Local governments will no longer have the luxury of spending money without strict
examination. The Ministry of Finance pushes local governments to compose balance sheet
statements, establishing a foundation so the market can evaluate and price their credit risk in
the future as well.
The State Council decided to separate debts that local government borrowed for public
interest from those debts borrowed for corporate activities, such as property construction.
The State Council then published guidance on 2 October 2014. Debts for public interest
would be officially acknowledged as local government debt and are encouraged to be
replaced by new issued local government bonds. On the other hand, the State Council
clearly state that debts raised for corporate activities should be treated as normal corporate
debts.
Moreover, future fiscal reform will match the revenues of local governments with their
responsibilities, according to finance minister Lou Jiwei. The local government debt issue will
become manageable as reform advances. Both public expenditure and the private sector
have relied on the shadow banking system to finance their projects in recent years. Coping
with public finance issues successfully will significantly reduce the size of the implicit
guarantee problem and make withdrawal of such guarantees controllable.
34
Economics Update
Box 5: How does shadow banking relate to government’s debt
problem?
Debt financed by local government WMP escalated rapidly
The result of the national audit on China’s government debt, released at end-2013, stated
that new debt has been raised mainly through city-level government issuance of wealth
management products (WMP) such as local government financing vehicle (LGFV) bonds, to
fund urban infrastructure, transportation facilities and land development (see Local
government debt under control, 6 January).
While the audit was clear that the overall size of debt remained under control, it was
consistent with the growing shadow-banking industry. Trust loans in 2012, in particular, had
expanded to more than 6x the 2011 figure. In 1Q13, the growth in trust loans and corporate
bonds (~87% of corporate bond issuance was related to LGFVs) soared to the equivalent to
40% of the total social financing increase in 2012 (see Strong credit and monetary data
reduce over tightening worry, 11 April 2013). Together, they form the main economic risk for
China in 2014, in our view.
Fig 36 LGFVs remain the main tool for local government borrowing
Self-funded
enterprises
3%
Others
2%
Public enterprises
2%
SOE
18%
LGFV
39%
Government-funded
enterprises
13%
Government
departments
23%
Source: NAO, Mizuho research
35
Economics Update
Breaking implicit guarantees with preparation
With the public finance issue under control, the regulators may allow the breaking of
implicit guarantees among borrowers in the private sector: In late April 2014, the PBoC
stated in its Financial Stability Report to “let defaults happen naturally when risk is
manageable”, and “to enhance investors’ awareness of risk”. In July, the CBRC published No
35 guidance of 2014 on WMP regulation, requiring banks to set up an independent WMP
department, to segregate the funds of each WMP from each other as well as from the banks’
own capital and to educate investors to “take their own risk.”
As default cases are occurring more frequently recently, it is not surprising that implicit
guarantees will be broken in a few cases. To minimize the impact on the economy, we
believe governments would choose those cases involve a smaller scale of loans and
relatively less investors.
On 24 July 2014, China Credit Trust announced that its CNY1.3b Credit Equals Gold No 2
Collective Trust Product could not be repaid by its due date (25 July). The payment would
need to be delayed for at least 15 months, as the trust company would need to try to
restructure and liquidate collaterals during this period. To a certain extent, implicit guarantee
had already been broken in this case. Similar to the famous Credit Equals Gold #1 Collective
Trust Product case, the borrower is a private mining company in Shanxi Province (see Focus
on the risk in China’s trust industry 21 February). Its impact to the market was limited
because scale of the trust product, CNY1.3b, is much smaller than the CNY3b Credit Equals
Gold No 1 Collective Trust.
Another case in point is the bond default of Shanghai Chaori Solar Energy Science &
Technology on March 2014. The company was unable to meet the CNY89m interest
payment on its CNY1b “Chaori-11 bond” issued in 2011. Given relatively small scale of the
bond, the default did not cause too much systematic risk to the financial market, as we
anticipated. But the event did lead to more reasonable pricing of risk in the market, which is
conducive to the financial market’s structural reforms. (See The implication of China’s first
bond default, 5 March)
36
Economics Update
Policy response 3: Assure a “soft landing”
for the property sector
In these three default cases, the property sector played a central role. On one hand, the
default of CMG and Handan’s underground lending market can be directly attributed to the
slowdown of property sales. On the other hand, a major usage of steel in China is housing
construction, thus Sino Steel’s revenue is indirectly affected by the property market.
In fact, not only does property investment directly contribute to growth, but also revenue from
property sales influences government investment on infrastructure and expenditure on
welfare. Furthermore, home appliances and furniture sales are significantly related to
property sales.
Most important, property and land serves as the major collateral of the financial system. Data
suggests that property-related loans accounted for 35% of total loans by the end of 2013;
44% of property loans have been offered since 2013 when property prices were approaching
a peak. Moreover, 86% of LGFV loans have property as collateral and 50% of long-term (1
year and above) WMP are invested in property. Thus, the collapse of the property market is
devastating to the entire economy.
Although property is of great importance to the economy, the situation is particularly bad in
the property sector. Both transaction volumes and prices declined in the past a few months.
We believe the government will ensure that the property market experiences a “soft
landing”. We expect new measures to be adopted by the government to support the
property sector, including the relaxation of housing purchase restrictions and the reduction of
mortgage rates. On 30 Sep, the PBoC and CBRC jointly announced that if a family has paid
back a mortgage, banks should treat the family as a first-time buyer and offer favourable
mortgage rates when the family applies for a new mortgage to improve its living condition.
Fig 37 Property sales and average mortgage rates in China
120
7.5
100
7.0
80
6.5
60
6.0
40
5.5
20
5.0
0
4.5
YoY%
8.0
-20
4.0
Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Property sales
Source: PBoC, CEIC, Mizuho research
37
Mortgage rate (RHS)
%
140
Economics Update
14 November 2014
Weak credit data calls for RRR & rate cuts
 China’s new-loan growth in October was below expectations, despite the
government’s liquidity injections in September and October. In our view,
mortgage loans may accelerate in coming months, but disappointing corporate
loans were consistent with weak investment growth amid excess capacity. More
importantly, the PBoC’s easing through targeted measures may not be effective.
We maintain that conventional interest rate and RRR cuts are necessary.
Fig 38 Key economic indicators
(YoY %)
New loans (CNYb)
M2 (YoY %)
Total social financing (CNYb)
Sep
Oct (est)
Oct (actual)
857.2
700.0
548.3
12.9
12.7
1050.0
12.6
662.7
Source: CEIC, Mizuho research
Disappointing loan growth reflects on downbeat economic demand: China’s new loan
growth increased CNY548.3b in October, below September’s CNY857.2b and our forecast of
CNY700b. In our view, this confirms that China’s underlying demand for credit remains weak, as it
was consistent with the disappointing investment growth 15.9% YoY YTD in October (see Weak
data fits in with a lower 2015 growth target, 13 November). It also shows that the liquidity
injections are so far insufficient to stimulate the credit market and reinforces our view that RRR
and interest rate cuts will likely be announced soon. In October, money supply (M2) also slowed
to 12.6% YoY from 12.9% YoY in September.
Mortgage loan may recover with a lag: The breakdown showed that the slowdown in loan
growth was across-the-board, as household loan growth nearly halved to CNY158.5b in
October from CNY300.9b in September, while loan growth in the corporate sector was also
weak at CNY389.0b against CNY553.7b in September. Following the government’s stimulus
to the housing market at end-September, housing transactions began to stabilize. We believe
its impact on mortgage loan growth will be reflected in the coming months. However, weak
loan growth in the corporate sector reflects weak demand amid excess production capacity
in the industrial sector.
Shadow banking deleveraging continued: Total social financing expansion slowed to
CNY662.7b in October from CNY1050.0b in September. In addition to slowing bank loan
growth, trust loans and bankers’ acceptance note issuances continued to fall in October,
down by CNY21.5b and CNY241.3b, respectively, as shadow-banking deleveraging
continued.
Weak economy calls for more effective easing: In its 3Q14 monetary policy report, the
PBoC confirmed that it injected CNY770b over September and October through its mediumterm lending facility (MLF), and cut interest rates on 14-day repos in its open-market
operation twice (see Deflationary environment conducive to further monetary easing by the
PBoC, 10 November). While a lag is possible, generally we maintain our view that targeted
easing has so far proved ineffective at easing China’s slowing growth momentum. Instead of
targeted measures, we continue to expect conventional monetary policy instruments such as
RRR and interest rate cuts to be announced soon, perhaps by December at the earliest.
38
Economics Update
Fig 39 Loan and money supply growth in October were disappointing
Money supply
New loans
1,400
20
18
1,200
16
14
800
YoY%
CNYb
1,000
600
12
10
8
400
6
200
4
2
0
Jan-14
Apr-14
Jul-14
Actual new loans
0
Oct-11
Oct-14
Target
Apr-12
Oct-12 Apr-13
M1
Oct-13
M2
Apr-14
Oct-14
Source: CEIC, Mizuho research
Fig 40 While mortgage loans may pick up amid government easing, weak corporate loans amid excess capacity is a concern
Non FI & Others
Household
800
500
700
600
300
500
CNY bn
CNY bn
400
200
400
300
200
100
100
0
0
-100
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
-100
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
Short term loan
Medium to long term loan
Short term loan
Medium to long term loan
Source: CEIC, Mizuho research
Fig 41 Impact from liquidity injection has not been reflected
Fig 42 Shadow-banking deleveraging continues
17
2.5
16
2.0
15
1.5
CNYt
14
YoY%
Total social financing
13
1.0
12
0.5
11
0.0
10
-0.5
9
8
Oct-11
Apr-12
Oct-12
Apr-13
RMB Loan
Oct-13
Apr-14
Oct-14
-1.0
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
Bond and equity
RMB deposit
Source: CEIC, Mizuho research
39
Trustand bankers' acceptance
RMB loan
Economics Update
10 November 2014
Deflationary environment conducive to
further monetary easing by the PBoC
 October CPI and PPI suggest that deflation will continue in the coming months,
with relatively mild weather for food production, falling fuel prices and excess
production capacity. This should lead to a more favourable environment for
policy easing, as reiterated in the PBoC’s 3Q14 monetary policy report.
 The PBoC made reducing funding costs its policy priority, as well as providing a
reasonably accommodative monetary environment. In our view, the targeted
easing tools preferred by PBoC will not be efficient and interest rate and RRR
cuts are necessary for further easing.
Fig 1 Projections for key economic indicators
(YoY %)
Sep
Oct (est)
Oct (act)
CPI
1.6
1.6
1.6
PPI
-1.8
-2.0
-2.2
Source: CEIC, Mizuho research
China’s deflationary environment unlikely to change soon: China’s October CPI
remained unchanged from September at 1.6% YoY as expected. While the price of food
increased 2.5% YoY in October vs 2.3% YoY in September, it was countered by non-food
inflation, which slowed to 1.2% YoY (from 1.3% YoY) its lowest point since March 2010. In
October, the contribution to CPI from base effect remained steady from September at 0.3ppt.
Food prices were slightly higher in October compared to September due to base effect from
fruit and egg prices. MoM, relatively favourable weather in 2014 actually led to lower fruit and
vegetable prices than the historical average of 0.5% and 2.2% declines. Pork prices also
eased 0.6% MoM and 3.1% YoY, suggesting that food inflation will remain moderate in the
near future with dampened pork price volatility (see Base effect behind inflation jump in May
10 June).
Meanwhile, non-food inflation slowed further in October mainly due to lower domestic fuel
prices. Brent crude oil has fallen by close to 29% to USD82.2/barrel on 7 November from
USD115.4/barrel on 19 June. Domestic fuel prices as set by the National Development and
Reform Commission (NDRC) also dropped by 14.8% to CNY7,655/ton on 1 November from
CNY8,980/ton in end-September.
Notably, the price for renting a residence began to accelerate to 2.7% YoY in October from
2.6% YoY in September after eight consecutive months of decline. This is another signal that
China’s property market is stabilizing following easing measures in September.
PPI dragged by falling commodity price: Falling commodity prices, along with excess
production capacity, also led to further deterioration in China’s Producer Price Index (PPI) to
2.2% YoY in October, vs 1.8% YoY in September. Purchasing price index, which reflects the
input price for manufacturers, fell 2.5% YoY in October from a 1.9% YoY decline in
September. Other than oil and fuel prices, prices of most other key commodities also saw a
broad-based decline in October, including ferrous metal (-6.9% YoY), non-ferrous metal (2.5% YoY), textile (-1.7% YoY), chemical (-1.4% YoY), and building materials (-1.1% YoY).
The persistent deflation in PPI reflects the serious situation in the manufacturing sector amid
the weak momentum in China’s economy.
PBoC promises to reduce funding costs and keep liquidity reasonable: We expect the
downbeat inflationary environment to continue in the coming months, leading to a more
favourable environment for policy easing. In fact, the PBoC’s 3Q14 monetary policy report
40
Economics Update
has made reducing funding cost for corporate and property market their priority, and
promised to launch more counter-cyclical measures to maintain reasonable growth in market
liquidity.
The report confirmed that PBoC injected CNY770b over September and October through its
medium-term lending facility (MLF) with a tenor of 3 months at an interest rate of 3.5%, in
addition to promising its supplementary lending facility (PSL) would improve credit provision
for: 1) small- and medium-sized financial institutions; and 2) large financial institutions that
support shantytown renovation and trade.
As a result, the PBoC suggested that its policies had already achieved some success in
lowering borrowing costs. The weighted-average lending rate for nonfinancial firms stood at
6.97% in September, down 0.12ppt from a month earlier and down 0.23ppt from end- 2013.
Overall, the PBoC reiterated its preference for its new targeted monetary-easing tools and its
willingness to use them to maintain a generally accommodative monetary environment to
stabilize growth. We understand that the PBoC may be concerned about the negative image
from broad-based easing, fearing association with the massive stimulus over 2008-09. In our
view, such targeted easing measures should not replace conventional tools.
We believe that the targeted measures: 1) lack transparency and market participation; 2) are
a step backward for China’s financial marketization; 3) are a misuse of the PBoC’s
mechanisms as the lender of last resort during emergency situations; and 4) bypass regular
policymaking mechanism (see The PBoC’s confused monetary policy, 28 May). We maintain
our view that further easing using more efficient tools including interest rate and RRR cuts
are still needed before year-end.
Fig 2 CPI breakdown
Sep
1.6
0.5
2.3
0.8
1.3
0.3
CPI (YoY %)
CPI (MoM %)
Food (YoY %)
Food (MoM %)
Non-food (YoY %)
Non-food (MoM %)
Oct (est)
1.6
-0.1
2.4
-0.3
1.2
0.1
Oct (act)
1.6
0.0
2.5
-0.2
1.2
0.2
Source: NBS, Mizuho research
Fig 3 China’s October CPI remained unchanged from September at 1.6% YoY
Base effect in 2014
15
2.0
1.8
12
1.6
1.5
1.3
1.4
9
1.1
1.2
%
YoY %
1.6
1.5
1.4
1.0
1.0
6
0.8
0.6
3
0.4
Food
0.3 0.3 0.3 0.3
0.2
0
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
CPI
0.4
0.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Non-food
Source: CEIC, Mizuho research
41
Economics Update
Fig 4 Food prices edged higher in YoY terms in October but showed mild inflationary pressure MoM
Food price
2
10
1
5
0
0
-1
-5
-2
-10
-3
Oct-13
Jan-14
MOC
Apr-14
Food price
15
MoM%
MoM%
3
Jul-14
CPI food price
-15
Oct-14
Oct-12
Jan-13
NBS
Apr-13
Fruit
Jul-13
Oct-13
Vegetable
Source: CEIC, Mizuho research
Fig 5 Pork price stable remained largely stable
Fig 6 Rent inflation picked up again in October
Pork to feed ratio
9.0
CPI
6.0
50
5.5
8.5
40
5.0
8.0
7.0
20
6.5
6.0
10
5.5
0
4.5
YoY %
30
YoY %
7.5
4.0
3.5
3.0
2.5
2.0
5.0
-10
4.5
1.5
1.0
Oct-11
4.0
-20
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
Pork to feed ratio
Apr-12
Oct-12
Apr-13
Rent
Pork price (RHS)
Oct-13
Apr-14
Oct-14
Residence
Source: CEIC, Mizuho research
Fig 7 Lower oil prices strong contributor to lower inflation in October
Transportation and communication CPI
1.5
1.0
Brent crude oil
120
15
9,000
115
10
8,800
0.0
0
-0.5
-5
-1.0
-10
USD/Barrel
5
-1.5
-15
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
Transport and communication
Fuel and parts (RHS)
8,600
105
8,400
100
95
8,200
90
8,000
85
7,800
80
Nov-12
May-13
Brent crude oil
Source: CEIC, Mizuho research
42
Nov-13
May-14
7,600
Nov-14
Domestic gasoline price (RHS)
CNY/Ton
0.5
YoY %
YoY %
110
Economics Update
Fig 8 PPI deflation deteriorated further to 2.2% YoY in October
PPI
8
10
8
6
6
4
4
YoY %
YoY %
2
0
.
2
0
-2
-2
-4
-4
-6
Oct-11
Apr-12
Oct-12
Apr-13
Oct-13
Producer goods
Apr-14
-6
Oct-11
Oct-14
Consumer goods
Apr-12
Oct-12
Apr-13
Producer price index
Oct-13
Apr-14
Oct-14
Purchasing price index
Source: CEIC, Mizuho research
Fig 9 Commodity prices were lower across the board
Purchasing price index
15
Purchasing price index
14
12
10
10
8
6
YoY %
YoY %
5
0
.
4
2
.
0
-5
-2
-4
-10
-6
-15
Oct-11
Apr-12
Oct-12
Fuel
Apr-13
Oct-13
Ferrous metal
Apr-14
-8
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
Oct-14
Chemical
Non-ferrous metal
Textile Material
Building Material
Source: CEIC, Mizuho research
Fig 10 Interest rate cuts would be more effective easing tool than targeted measures
900
Weighted average lending rate
8.5
800
700
8.0
CNYb
600
7.5
500
400
%
7.0
300
6.5
200
100
6.0
0
Jul-13
Oct-13
Jan-14
SLF
Apr-14
Jul-14
Oct-14
MLF
Source: CEIC, Mizuho research
43
5.5
Sep-10
Sep-11
Sep-12
Sep-13
Sep-14
Economics Update
20 October 2014
Another round of stealthy monetary easing
 Media reports say that the PBoC will use SLF again to inject up to CNY200b into
20 banks. In our view, this is another round of de facto monetary easing.
Although these measures lack transparency and market accessibility,
policymakers have disguised their efforts to ease market interest rates as
outright RRR and interest rate cuts have been mistakenly regarded as a form of
large stimulus.
 We maintain that the government will launch appropriate policies to avoid risk of
a hard landing, while providing a more accommodative environment for
structural reforms. In our view, RRR and interest rate cuts are still the best
solution, and more visible slowdown will push the PBoC to announce an outright
cut by end-2014.
De facto monetary easing through liquidity injection: Chinese media reported over the
weekend that the PBoC is planning to use its standing lending facility (SLF) to inject up to
CNY200b into 20 banks, mainly joint-stock banks. In our view, this is another round of de facto
monetary easing, aimed at cutting RRR and interest rates. In fact, interbank rates and mortgage
rates have declined since mid-September, after the injection of CNY500b of SLF to five major
banks (see Stealthy monetary easing to avert hard-landing risk 17 September).
We believe that one of the most important debates on China’s economic policy in 2014 is
whether and when the government will cut RRR and interest rates. We have consistently
argued for multiple RRR and rate cuts since 1Q14 (see How to stimulate the economy, 4
April and Why the PBoC has to cut the RRR, 7 May). However, the PBoC is making every
effort to achieve lower interest rates without officially announcing a cut.
As cutting RRR and interest rates is now mistakenly regarded as a large form of stimulus,
the cuts are now disguised as "targeted cuts", "SLF", or "pledged supplementary lending
(PSL)". We think such piecemeal measures are economically inefficient, as they lack
transparency and market accessibility, and we believe they are working against China’s
economic structural reform (see Targeted RRR cut vs de facto general cut, 3 June).
Policymakers should adopt general price-based tools: We believe that an RRR cut is not only
a short-term measure against an economic slowdown and high financing costs, but also the
appropriate monetary policy tool to use. There are four reasons for an RRR cut: 1) interest rate
liberalization has taken off, and price-based tools allow more efficient resource allocation in the
market; 2) current market distortion due to onerous banking sector control; 3) the current RRR (at
20%) exceeds its optimal level as a policy tool; and 4) China’s RRR is much higher than global
standards, suggesting a distortion in the credit environment. After the RRR is cut, we think that the
government should focus on price-based measures to establish an effective monitoring
mechanism (see Unleashing loan demand through policy normalization, 12 May).
Weakening economy makes easing necessary: The PBoC initially argued against any form of
easing, stating that their main aim this year is de-leveraging – ie, monetary tightening. The central
bank projected a strong outlook in 1Q14 and aggressively cracked down on shadow banking. But
a weakening economy forced the PBoC to change its monetary policy, by first announcing a
"targeted” RRR cut at end May.
On 15 September, we again argued that further monetary easing in the form of RRR and
interest rates cuts were necessary to reverse the downward trend in growth. Two days later,
the PBoC announced to inject CNY500b through SLF into five major banks, a stealthy easing
equivalent to a 50bp cut for the entire banking sector (see Stealthy monetary to avert hardlanding risk 17 September).
44
Economics Update
We also observed that the government has shifted from supporting growth to a “crisis
prevention” mode, which should be more accommodative to structural reforms while
tolerating slower growth (see China's new norm of a lower growth target, 22 September).
However, we maintain that the government will monitor the economy closely, and launch
appropriate policies to avoid a hard landing (see Policy behind the curve, 18 September).
RRR and interest rate cuts by end-2014
In particular, the property market and the financial system are areas that require the greatest
policy attention in the economy, in our view. In fact, the government has continually launched
targeted measures in the hope of keeping the property market and the financial system from
more significant declines. However, the impact of the policy easing has been limited on the
property market, while the situation in the real economy has deteriorated (see Monetary
easing to accelerate, 16 October).
Now the PBoC has conducted another round of monetary easing by injecting CNY200b into
banks; it is still hoping to use monetary injections to replace general RRR or interest rate
cuts. But we continue to believe that RRR and interest rate cuts are necessary and the best
solution to the slowing growth momentum. We also think that a more visible slowdown in the
economy will finally push PBoC to announce an outright cut by year-end.
Fig 43 The government has cut repo rate to guide market interest rate lower
14-day repo rate
Interbank repo rate
5.5
3.9
5.0
3.8
4.5
4.0
%
3.7
%
3.5
3.6
3.0
3.5
2.5
2.0
3.4
3.3
Feb-14
1.5
Feb-14
Apr-14
Jun-14
Aug-14
Apr-14
Oct-14
Jun-14
7-day
Aug-14
Oct-14
Overnight
Source: CEIC, Mizuho research
Fig 44 The government has preferred stealthy easing such as SLF
Fig 45 Slowing economy to trigger outright cuts by end-2014
FAI
Standing lending facility (SLF)
800
700
26
35
24
30
22
25
20
20
18
15
CNYb
500
400
300
200
100
16
10
Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14
0
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
FAI
Sep-14
Source: CEIC, Mizuho research
45
Real estate investment (RHS)
%YoY YTD
%YoY YTD
600
Economics Update
16 October 2014
Monetary easing to accelerate
 China’s banking sector extended CNY857.2b of new loans in September, such
that 3Q14 loan growth is now back on track to reach the full-year loan-growth
target at CNY10t. This is thanks in part to the CNY500b liquidity injection in midSeptember, which helped counter the slowing growth momentum.
 The breakdown, however, showed that new loans were focused on short-term
corporate financing, while slowing long-term household loans suggest that
mortgage demand remained weak. Contracting FX reserves – despite a strong
trade surplus – also hurt China’s monetary base. Media reports that the
lacklustre home sales in October suggest more easing could be in the pipeline.
Fig 46 Key economic indicators
(YoY %)
New loans (CNYb)
M2 (YoY %)
Total social financing (CNYb)
Aug
Sep (est)
Sep (actual)
702.5
700.0
857.2
12.8
13.0
957.4
12.9
1050.0
Source: CEIC, Mizuho research
Credit growth on par to reach government target: China’s new loan growth rose CNY857.2b in
September, from CNY702.5b in August, suggesting that in 3Q14, China’s new CNY loans
expanded CNY1.94t, broadly in line with the CNY2t allotment needed to reach a full-year loan
growth target at CNY10t. Total social financing rose to CNY1.05t in September, vs CNY957.4b in
August, mainly due to loan growth, while trust loans and bankers’ acceptance notes continued to
decline in response to tighter regulations on the shadow banking system amid ongoing risk (see
Three new cases of shadow-banking risk, 16 October).
Money-supply growth picked up slightly to 12.9% YoY in September vs 12.8% YoY in August
– close to the government’s annual growth target at 13.0% YoY, but continuing relatively
weak in comparison to 1H14. We think this is likely due to the slowdown in monetary-base
expansion, under the constraint of capital outflows. China’s foreign exchange reserve as of
end-September also reported today, dropping to USD3.89t from USD3.99t at end-June. This
suggests that despite the sizeable external merchandize trade surplus at ~USD130b in
3Q14, other components in the balance of payment are in deficit.
Liquidity injected through SLF helped keep monetary condition accommodative: We
believe loan growth continued to normalize from dismal credit growth in July due to the CNY500b
liquidity injection into the five major banks through standing lending facilities (SLF) (see Stealthy
monetary easing to avert hard-landing risk, 17 September). The easing may help to support the
economy, which faces slower growth momentum.
However, the new loan growth was focused on short-term financing, especially the demand
from non-financial institutions. In September, short-term and bill financing for the corporate
sector rose CNY250.4b, close to 30% of total loan growth (vs CNY167.7b in August). Longterm household-loan growth – mainly as property mortgage – slowed to CNY170.7b in
September (vs CNY189.0b in August).
Housing market has not responded well to easing measures: The PBoC unveiled on 30
September its boldest measures yet to prevent a collapse in the housing market by reducing
mortgage rates for first-time buyers and treating second-home buyers with no outstanding
mortgage as first-time buyers (see “Crisis prevention” policymaking in action, 9 October).
However, according to the state media China News, not a single lender has responded to the
PBoC’s change, as banks have little incentive to offer mortgage loans that are relatively
unprofitable even before the policy change. Property transactions to 14 October, including
46
Economics Update
the national day holiday, dropped 12.6% YoY despite some developers abandoning earlier
discounts in anticipation of a rise in demand. Nevertheless, we maintain that the government
is ready to launch more targeted measures at the housing market if situation continues to
deteriorate (see More room for targeted mortgage rate cuts, 12 September).
More easing measures necessary amid deflation risk
In September, the weighted average for the overnight interbank rate eased to 2.97% –
0.20ppt below a month ago. The interbank bond collateral repo rate also eased to 2.93%,
down 0.18ppt from August. As part of the drive to lower the funding costs of the real
economy, the PBoC cut the interest rates offered in the repo sales first from 3.7% to 3.5% on
18 September, and then to 3.4% on 14 October.
In our view, broad-based easing, such as across-the-board cuts in RRR and deposit interest
rates, is more effective in supporting the real economy as evident from the producer price
index (PPI) deflation (see Deflation risk calls for rate cuts 15 October).
Fig 47 Loan growth returned on track to reach CNY10t in 2014
Money supply
New loans
1,400
20
18
1,200
16
14
800
12
YoY%
CNYb
1,000
600
10
8
400
6
4
200
2
0
Jan-14
Apr-14
Jul-14
Actual new loan
0
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
M1
M2
Oct-14
Target
Source: CEIC, Mizuho research
Fig 48 FX reserve contracted in 3Q14 despite sizeable trade surplus
Foreign Reserve (net change)
60
200
150
YoY %
USD b
USDbn
100
50
45
50
40
35
40
30
30
25
20
20
15
10
10
5
0
0
-5
-10
-10
-15
-20
-20
-30
-25
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
50
0
-50
-100
-150
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Source: CEIC, Mizuho research
47
Trade balance (RHS)
Export
Import
Economics Update
Fig 49 CNY500b SLF injection kept condition accommodative
Fig 50 TSF weighed upon by shadow-banking consolidation
Standing lending facility (SLF)
Total social financing
2.5
600
2.0
500
CNYt
1.5
CNY b
400
1.0
0.5
300
0.0
200
-0.5
100
-1.0
Sep-12
0
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Bond and equity
Sep-14
Mar-13
Sep-13
Mar-14
Trustand bankers' acceptance
Sep-14
RMB loan
Source: CEIC, Mizuho research
Fig 51 Loan growth was more concentrated on short-term financing
New CNY loan
New CNY loan
1,100
1,200
900
1,000
700
800
CNYb
1,400
CNYb
1,300
500
600
300
400
100
200
-100
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Short-term and bill financing
0
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Medium to long term loan
Non financial institutions
Household
Source: CEIC, Mizuho research
Fig 52 Weak household long-term loan growth suggests lack of mortgage demand
Non FI & Others
Household
800
500
700
400
500
CNY bn
CNY bn
600
400
300
200
300
200
100
100
0
0
-100
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Short term loan
-100
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Short term loan
Medium to long term loan
Source: CEIC, Mizuho research
48
Medium to long term loan
Economics Update
Fig 53 Property sales has not recovered in October
Fig 54 More can be done to cut market interest rate
Residential property sales
Weighted average interbank offered rate
8
120
100
7
80
6
60
5
%
YoY%
40
20
0
4
-20
3
-40
-60
2
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
-80
Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14
1-month
7-day
Overnight
Source: CEIC, Mizuho research
Fig 55 OMO repo rate has been cut two times since September
14-day repo rate
Net OMO fund injection
120
3.9
100
3.8
80
60
CNY b
3.7
%
40
3.6
20
3.5
0
-20
3.4
-40
3.3
Feb-14
Apr-14
Jun-14
Aug-14
-60
25-Apr
Oct-14
6-Jun
18-Jul
29-Aug
10-Oct
Source: CEIC, Mizuho research
Fig 56 Deposit rate and general RRR cut could be in the pipeline
Required reserve ratio
10
23
8
21
19
17
15
4
%
%
6
13
2
11
9
0
7
Oct-06
-2
Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
Deposit rate: one year
CPI:YoY
Est.
Source: CEIC, Mizuho research
49
Oct-08
Oct-10
Oct-12
Oct-14
Large financial institutions
Rural cooperatives
Small and medium-sized financial institutions
Rural commercial banks
Economics Update
15 October 2014
Deflation risk calls for rate cuts
 China’s CPI inflation eased further in September, reflecting not only a reduced
contribution from base effect but also milder-than-usual price increases. Also,
deteriorating PPI deflation –now at its longest streak in nearly 20 years –
suggests that apart from lower commodity prices, excess capacity and lack of
demand for products have put the manufacturing industry in grave situation. We
believe that broad-based easing, such as across-the-board cuts in RRR and
deposit interest rates, appears more likely by the end of this year.
Fig 11 Projections for key economic indicators
(YoY %)
Aug
Sep (est)
CPI
2.0
1.6
Sep (actual)
1.6
PPI
-1.2
-1.3
-1.8
Source: CEIC, Mizuho research
CPI disinflation due to subdued MoM inflation and sharply lower base effect: CPI inflation in
September slowed to 1.6% YoY, in line with our expectation but below the market’s forecast of
1.7% YoY. It was the lowest increase since November 2009. Food and non-food prices both
eased in September to 2.3% YoY and 1.3% YoY, respectively, from 3.0% YoY and 1.5% YoY.
In our view, the falling CPI was partly caused by sharply weaker contribution from base effect
(0.3ppt in September from 1.0ppt In August,) while the MoM increase also remained
subdued. Food prices rose 0.8% MoM in September, above 0.7% MoM in August. Food
prices were mainly driven by a 3.9% MoM increase in vegetable prices and 1.5% MoM
increase in fruit prices – much milder than the 5.8% MoM and 5.4% MoM increases in
August. Pork prices, which rose strongly at 5.1% MoM in August, slowed to 2.3% MoM in
September, suggesting the pork-price cycle has become more moderate (see China’s
looming deflation concerns, 11 September).
September is typically a month that shows one of the highest rates of Inflation in the year in
MoM terms as school year begins. As a result, non-food inflation rose 0.3% MoM in
September (from a 0.1% MoM decline in August) due to 0.9% MoM increase in recreational,
educational, and cultural activities, and a 1.0% MoM increase in clothing price. Also,
residence inflation slowed for the eighth consecutive months in YoY term to 1.6%, or 0.1%
MoM in September.
PPI suggests weak product demand and a difficult time for manufacturers
Meanwhile, producer price index fell for the 31st consecutive month in September (-1.8%
YoY from -1.2% YoY in August). It is now on par with the longest PPI deflation streak seen
over 1997-99. The purchasing price index also fell 1.9% YoY in September from a 1.4% YoY
decline in August, reflecting falling commodity prices for oil and steel. Among the 30
industries followed by the PPI, prices for 7 increased, 5 stayed flat, and 18 declined.
In contrast to the from CPI slowdown, which was driven partly by base effect, the falling PPI
was caused completely by new contribution, as the base effect was much milder with no
effect in September and 0.2ppt positive contribution in August. The persistent deflation in PPI
reflects the grave situation for the manufacturing sector amid the weak momentum in China’s
economy.
At this point, we maintain that the government is in a “crisis prevention” mode, being more
accommodative to structural reforms while tolerating lower growth. Nevertheless, we expect
the government to continue supporting the economy should downside risks become greater
(see China's new norm of a lower growth target, 22 September). We believe that broad-
50
Economics Update
based easing, such as across-the-board cuts in RRR and deposit interest rates, appears
more likely by the end of this year.
Fig 12 CPI breakdown
Aug
2.0
0.2
3.0
0.7
1.5
-0.1
CPI (YoY %)
CPI (MoM %)
Food (YoY %)
Food (MoM %)
Non-food (YoY %)
Non-food (MoM %)
Sep (est)
1.6
0.2
2.2
0.6
1.1
0.0
Sep (actual)
1.6
0.5
2.3
0.8
1.3
0.3
Source: NBS, Mizuho research
Fig 13 CPI disinflation worsened to 1.6% YoY in September
4
15
2
9
MoM%
YoY %
12
0
6
-2
3
-4
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
0
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
CPI
Food
Non-food
CPI
Food
Non-food
Source: CEIC, Mizuho research
Fig 14 Pork price inflation stays moderate in September
Food price
3
9.0
Pork to feed ratio
8.5
2
40
8.0
1
0
7.5
30
7.0
20
6.5
-1
6.0
10
5.5
0
YoY %
MoM%
50
5.0
-2
-10
4.5
-3
Sep-13
Dec-13
MOC
Mar-14
CPI food price
Jun-14
Sep-14
4.0
-20
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
NBS
Pork to feed ratio
Source: CEIC, Mizuho research
51
Pork price (RHS)
Economics Update
Fig 15 Vegetable and fruit price increase are actually below seasonal pattern
Vegetable price
30
Fruit price
15
25
10
20
5
MoM %
MoM %
15
10
5
0
-5
0
-5
-10
-10
-15
-15
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2009
2010
2011
2012
2013
2014
2009
2010
2011
2012
2013
2014
Source: CEIC, Mizuho research
Fig 16 Education and clothing prices jumped in September, in line with seasonal pattern
Clothing price
2.0
1.0
1.5
1.0
0.5
MoM %
MoM %
Recreation, education & cultural
1.5
0.0
-0.5
0.5
0.0
-0.5
-1.0
-1.0
-1.5
-1.5
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2009
2009
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
Source: CEIC, Mizuho research
Fig 17 Residence inflation eased for the eighth months
Fig 18 Base effect in September dropped to 0.3ppt
CPI
6.0
Base effect in 2014
2.0
5.5
1.8
5.0
1.6
1.3
1.4
4.0
1.1
1.2
3.5
%
YoY %
4.5
1.6
1.5
1.5
1.4
1.0
1.0
3.0
0.8
2.5
0.6
2.0
0.4
1.5
0.3
0.2
0.3 0.3
0.2
1.0
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Rent
0.4
0.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Residence
Source: CEIC, Mizuho research
52
Economics Update
Fig 19 PPI dropped 1.8% YoY in September
12
PPI
8
10
6
8
4
2
4
YoY %
YoY %
6
2
0
0
.
-2
-2
-4
-4
-6
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
-6
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Producer price index
Producer goods
Purchasing price index
Consumer goods
Source: CEIC, Mizuho research
Fig 20 Commodity price has been falling
Brent crude oil
Steel
140
8,900
20
130
8,700
18
120
16
110
8,300
14
100
8,100
12
90
110
8,500
105
100
95
Sep-12
Mar-13
Sep-13
Brent crude oil
Mar-14
7,900
Sep-14
Dec 1994=100
22
CNY/Ton
USD/Barrel
115
9,100
Ton m
120
10
80
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
Domestic gasoline price (RHS)
Inventory
Price (RHS)
Source: CEIC, Mizuho research
Fig 21 PPI deterioration was caused by new contribution
Fig 22 We expect interest rate cut soon
2014 PPI base effect
0.5
0.3
10
0.2
8
0.0 0.0 0.0 0.0
0.0
6
%
%
0.0
-0.5
-0.5
2
-1.0
-1.2
0
-1.5
-1.6
-2.0
4
-2
Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
-1.8 -1.8
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Deposit rate: one year
Est.
Source: CEIC, Mizuho research
53
CPI:YoY
Economics Update
17 September 2014
Stealthy monetary easing to avert hardlanding risk
 Chinese media reported that the PBoC injected CNY500b into the market through
SLF to the five major banks. As “stealthy easing”, the immediate impact of the
stimulus is equivalent to a 50bp RRR cut. The easing may help to support the
economy, which faces rising risk of a hard landing. However, we believe the tool,
which is akin to printing money, is a misuse of the PBoC’s last-resort mechanism
while general RRR and interest rate cuts remain options.
A “stealthy easing” equivalent to 50bp RRR cut: According to Chinese media, on 16
September the PBoC injected CNY500b into the five major banks through standing lending
facilities (SLF). It was reported that each banks received CNY100b in liquidity at below the
ongoing market interest rate. Described by the market as a “stealthy easing”, the immediate
impact is equivalent to a 50bp general required reserve ratio (RRR) cut.
The CNY500b facility is valid for three months according to the report. The SLF is a recent
policy innovation by PBoC to regulate monetary conditions (see PBoC intervenes to preempt short-term liquidity stress, 22 January). Normally a short-term facility valid from one to
three months, the SLF has the benefit of allowing the PBoC to inject liquidity to specific
institutions as needed. However, the PBoC only reports the outstanding SLF balance on a
monthly basis, with no announcement for individual transactions.
The urgency for more policy easing: The timing of the easing confirmed our view that that
further stimulus is urgently needed as the economy approaches hard landing (see Rising risk of
hard landing a wakeup call, 15 September). The economy deteriorated sharply in August, as both
investment and production growth fell to their weakest levels in recent years. The economy was
weighed upon by the property market downturn, which has worsened despite typical seasonal
strength in September. In the week ending 13 September, real estate transactions in the top 20
cities fell 16% WoW. We have already lowered our 3Q14 GDP forecast to 7.2% YoY from 7.5%
YoY.
As the PBoC set interest rates on the SLF below market level, it also put pressure on the
banking sector to reduce the market interest rates. So far, the financial sector has been
criticized for not providing sufficient affordable credit to the specific sectors that could benefit
the most from credit easing – eg, small-and- medium-sized enterprises (SMEs), agriculture,
and hi-tech industries (see State Council urges easing of credit policy, 14 August). We
maintain that the government must ensure the real estate sector can also benefit through
reducing the cost for first-home mortgages.
Misuse of last-resort mechanism: While we believe that the timing for injection is right, the tool
is less than ideal. The PBoC has increasingly been relying on the less transparent and more
discretionary policy tools for liquidity management. As a general tool, we believe the SLF should
not replace the role of traditional monetary policy tools such as changing the RRR and open
market operations. The SLF is biased toward certain market participants, and is thus a step back
in China’s financial market reforms (see The PBoC’s confused monetary policy, 28 May). The SLF
process creates base money and is akin to printing money. Thus, in our view, not the proper use
of a tool the PBoC’s says is a “last-resort” mechanism.
54
Economics Update
Fig 57 Media reported the PBoC injected CNY500b through SLF in the week after the release of dismal August economic data
Standing lending facility (SLF)
14
600
15
13
10
12
11
YoY %
400
300
5
10
0
9
200
8
YoY %
CNY b
500
-5
7
100
6
-10
Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14
0
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
VAI
Electricity production (RHS)
Source: CEIC, Mizuho research
Fig 58 Property sales have not improved in September as expected; thus, mortgage rates should be reduced
Residential property sales
Mortgage rate
8.0
120
100
7.5
80
7.0
60
6.5
%
YoY%
40
20
6.0
0
5.5
-20
5.0
-40
4.5
-60
-80
Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14
4.0
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Source: CEIC, Mizuho research
Fig 59 Still plenty of room for RRR cut and open market operation
Required reserve ratio
Net OMO fund injection
23
120
21
100
80
19
60
17
CNY b
40
%
15
20
13
11
9
7
Aug-06
0
-20
-40
Aug-08
Aug-10
Aug-12
Aug-14
Large financial institutions
Rural cooperatives
Small and medium-sized financial institutions
Rural commercial banks
-60
-80
-100
28-Mar
Source: CEIC, Mizuho research
55
9-May
20-Jun
1-Aug
12-Sep
Economics Update
28 August 2014
First targeted interest rate cut heralds
additional stimulus
 The PBoC announced it would cut interest rates on re-lending to agricultural
sector by 100bp. The total quota on the relending has been raised by CNY20b.
This is in response to the State Council’s request that the central bank to lower
credit costs in the economy, as well as slowing growth momentum. We believe
that the PBoC has embarked on a path of targeted interest rates cuts to
complement the targeted RRR cuts.
 Meanwhile, the State Council also released a new list of fiscal spending projects
in “bottleneck areas” such as environmental improvement, clean energy, and
healthcare. Together, we believe the government is becoming more proactive in
supporting economic growth, and we expect to see additional cuts in interest
rates and the RRR, as well as accelerated fiscal spending measures in coming
weeks.
First targeted interest rate cut to ease rural funding costs
The PBoC announced on Wednesday that it has provided local rural branches with CNY20b
to finance re-lending to the agricultural sector. The loans will be priced at 1% lower than the
current preferential rate of 3.35% for rural areas. In our view, this is the first targeted interest
rate cut, and it will play an important role in China’s expansionary monetary policy. The
PBoC’s action confirms our view that interest rate cuts would start in August (see State
Council urges easing of credit policy, 14 August).
In the State Council’s 10-point statement on 14 August, government leaders pledged to
provide a favourable funding environment through targeted monetary easing. In
Wednesday’s announcement, the PBoC also promised to reduce the credit cost for SMEs
and rural borrowers.
More fiscal spending on environment, energy, and healthcare
Meanwhile, Premier Li Keqiang promised at a State Council meeting to roll out a new list of
fiscal investment projects in areas that are now in a structural bottleneck, such as air- and
water-pollution prevention, and clean-energy projects such as wind and hydro power, and
nuclear plants.
Other areas will involve construction of healthcare facilities such as hospitals, traditional
Chinese medicine hospitals, nursing homes, facilities to care for the elderly and fitness
centre. The government will also lead in developing commercial health insurance to improve
the healthcare services. We expect such investments to have direct benefit on social welfare
and consumption.
The government is also studying detailed third-party research on improving policy coverage,
execution, and supervision to make its administrative services more efficient. The State
Council promised to simplify the monitoring system to ensure that key reform areas such as
poverty relief, water safety, and shantytown reconstruction will meet completion deadlines.
Stepping up the effort to support the economy
We believe that the measures announced by the PBoC and State Council yesterday
represent a step up from the existing policy easing measures to support economic growth,
which remains weak amid the housing market downturn. (see Weak HSBC flash PMI
confirms the need for further policy easing, 21 August).
56
Economics Update
Going forward, we continue to expect more easing measures, such as additional targeted
cuts to interest rates and RRR, and open market operations, along with more specific
measures to support a rebound of the property market. On the fiscal side, additional
spending on railways, social housing, environment, energy, and healthcare will accelerate.
Fig 60 The State Council pledged to cut funding costs through monetary easing
Repo rate
10
SHIBOR
8
9
7
8
6
5
%
%
7
6
4
5
3
4
2
3
2
Aug-13
5.0
Nov-13
Feb-14
May-14
1
Aug-13
Aug-14
Nov-13
Feb-14
Overnight
7-day
14-day
1-yr re-lending and re-discount rate
Aug-14
1-month
Government bond
5.5
4.5
May-14
5.0
4.0
%
%
4.5
3.5
4.0
3.0
3.5
2.5
2.0
Aug-99
3.0
Aug-13
Aug-02
Aug-05
Aug-08
Aug-11
Aug-14
Nov-13
Feb-14
20-yr
May-14
10-yr
Aug-14
1-yr
Source: Winds, CEIC, Mizuho research
Fig 61 HSBC flash manufacturing PMI fell to 50.3 in August, a three-month low
54
53
52
51
50
49
48
47
Aug-11
Feb-12
Aug-12
PMI
Source: CEIC, Markit, Mizuho research
57
Feb-13
Aug-13
HSBC PMI
Feb-14
Aug-14
Economics Update
13 August 2014
Weak credit data not a sign of tightening
 Growth in China’s bank loans and total social financing plunged in July, which the
PBoC attributed to: 1) correction after unusually strong credit expansion in June;
2) weak loan demand amid mild economic growth in 1H14 and a slumping housing
market; and 3) restrictions on deposit loss and rising non-performing loans.
 The PBoC noted that loan growth has been resilient so far in August, suggesting
that the decline was a one-off. We attribute the decline mainly to adjustment to
high monetary and credit data in June and believe that the government will push
for additional monetary easing to support economic growth in 2H14.
Fig 62 Key economic indicators
(YoY %)
Jun
Jul (est)
Jul (actual)
New loans (CNYb)
1080
750
385.2
M2 (YoY %)
14.7
14.5
Total social financing (CNYb)
1988
13.5
273.1
Source: CEIC, Mizuho research
Loan growth in July disappoints
China’s new loan growth slowed to CNY385.2b in July, from CNY1.080t in June, the lowest
amount since December 2009. The weak loan growth came mainly from a CNY37.10b
decline in short-term loans and bill financing compared to CNY591.0b growth in June. On the
other hand, medium-to-long term credit was relatively stable at CNY388.5b vs CNY467.8b in
June. By destination, loans extended to the corporate sector plunged to CNY177.3b in July
(vs CNY726.6b in June), while loans to the household sector slowed to CNY206.2b in July
(vs CNY357.5b in June). Money supply (M2) eased to 13.5% YoY in July from 14.7% YoY,
while M1 eased to 6.7% YoY from 8.9% YoY.
Three explanations from the PBoC
The PBoC offered three explanations for July’s disappointing loan growth:
 It was a consequence of unusually strong loan growth in recent months in addition
to the typical seasonal pattern in 3Q14;
 Demand for loans was weak following the economic slowdown in 1H14 and a
downturn in the housing market;
 Loan approval has been constrained by a seasonal decline in deposits, especially
as non-performing loans have been rising in the past 11 quarters, suggesting
greater caution in approving loans from risky sectors. Bank deposits fell by
CNY1.980t in July, much larger than CNY654.6b in April and CNY940.2b in January.
We believe that the disappointing loan growth is mainly explained as an adjustment
after strong growth in recent months. In fact, although new loan growth fell 45.0% YoY
in July, it increased by 30.1% and 25.1% YoY in May and June. The PBoC also
confirmed that the level of liquidity in the market was reasonable, and the
disappointing monetary data in July does not indicate a change in China’s monetary
policy.
Consolidation of shadow banking continues
Total social financing also plunged in July to CNY273.1b after expanding in June. However,
combing June and July, expansion of such financing was steady at CNY1.1t per month,
including monthly increases of CNY202.1b, CNY196.9b, and CNY52.1 in bond, entrusted
loans, and trust loans. Banker’s acceptance bills fell CNY136.0b over June and July,
reflecting increased risk control measures. The PBoC noted that consolidation of shadow
banking products would continue (see Takeaways from Beijing policy meetings, 25 June).
58
Economics Update
Monetary easing to continue despite one-off credit setback
The PBoC noted that renminbi loans have been increasing at ~CNY30b–50b/day in August,
suggesting that the sharp decline in July was a one-off. We maintain that monetary easing
will continue, as the PBoC’s 2Q14 monetary policy report suggests (see PBoC signals
monetary easing to continue, 4 August). To reduce credit costs to the real economy and
support growth, we expect additional targeted tools, such as pledged supplementary lending,
to be used to in combination with conventional-monetary tools, such as further RRR cuts,
open-market operations, and interest rate cuts, to direct credit to the real economy (see
Weak inflation conducive to further monetary easing in 2H14, 11 August).
Fig 63 New loan growth in July significantly below target
Money supply
New loans
1,400
20
18
1,200
16
14
800
YoY%
CNYb
1,000
600
12
10
8
400
6
4
200
2
0
Jan-14
Apr-14
Jul-14
Actual new loan
0
Jul-11
Oct-14
Jan-12
Jul-12
Target
Jan-13
Jul-13
M1
M2
Jan-14
Jul-14
Source: CEIC, Mizuho research
Fig 64 The weak loan growth came mainly through a decline in short-term loans and bill financing
New CNY loan
New CNY loan
1,400
1,300
1,200
1,100
1,000
800
700
CNYb
CNYb
900
500
600
300
400
100
200
-100
Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14
Short-term and bill financing
0
Jul-11
Medium to long term loan
Jan-12 Jul-12
Jan-13 Jul-13
Non financial institutions
Source: CEIC, Mizuho research
59
Jan-14 Jul-14
Household
Economics Update
Fig 65 Short-term corporate loans fell for the first time since end-2009
Non FI & Others
Household
800
500
700
400
500
CNY bn
CNY bn
600
400
300
200
300
200
100
100
0
0
-100
Jul-09
Jul-10
Jul-11
Short term loan
Jul-12
Jul-13
-100
Jul-09
Jul-14
Medium to long term loan
Jul-10
Jul-11
Short term loan
Jul-12
Jul-13
Jul-14
Medium to long term loan
Source: CEIC, Mizuho research
Fig 66 The drag from rising NPL growth should be minor
Non-performing loan
New deposit
5
1.20
4
300
1.15
3
290
1.10
0
1.00
-1
0.95
-2
0.90
-3
0.85
-4
Jul-11
Jan-12
Jul-12
Jan-13
Non financial institutions
Jul-13
Household
Jan-14
Jul-14
Others
Fiscal
270
%
280
1.05
1
%
CNYt
2
260
250
0.80
240
Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14
NPL
Provision coverage ratio (RHS)
Source: CEIC, Mizuho research
Fig 67 Consolidation of total social financing continues
Fig 68 Interbank repo rate within reasonable range
Weighted average interbank lending rate
7.0
6.5
6.0
5.5
%
5.0
Feb-14
4.5
Mar-14
Apr-14
Equity
Bond
BAN
Trust loan
4.0
Entrusted loan
CNYb
Total social financing
500
400
300
200
100
0
-100
-200
-300
-400
-500
3.5
3.0
2.5
May-14
Jun-14
2.0
Jul-11
Jul-14
Source: CEIC, Mizuho research
60
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Economics Update
4 August 2014
PBoC signals monetary easing to continue
 In the PBoC’s 2Q14 monetary policy report, policymakers confirmed that
monetary easing is already underway, leading to a reduction in borrowing rates.
In 2H14, the PBoC will continue to launch targeted monetary easing measures to
reduce credit costs to the real economy and support growth.
Monetary easing curbed borrowing cost
In the PBoC’s 2Q14 monetary policy report, we found that the policymakers are satisfied that
monetary easing is in progress and that borrowing costs have declined. The reported
highlighted that M2 growth in 1H15 was 14.7% YoY, 2.6ppt higher than in 1Q14 (see Robust
monetary easing to lift growth momentum in 3Q14, 15 July). Meanwhile, the scale of
expansion for social financing due to credit growth and a robust direct-financing market has
been unprecedented.
Subsequently, borrowing costs began to ease in 2Q14, and the weighted-lending rate has
dropped to 6.96%, 0.22ppt below 1Q14. In particular, the weighted costs for bill financing fell
to 5.51%, 0.77ppt below 1Q14. Going forward, reducing borrowing costs will continue to the
focus of PBoC’s monetary policy in order to provide affordable credit to the real economy —
eg, small and medium sized enterprises (SMEs), the agricultural sector, and new industries.
Targeted measures to support growth in 2H14
However, the report acknowledged widespread differences between sectors that have little
access to affordable credit to sectors that are troubled by excessive debt. As a result, the
PBoC emphasized that targeted easing measures are necessary to direct affordable credit to
the appropriate sectors, such as SMEs, the agricultural sector, and important industries such
as technology, information consumption, and other strategic new industries.
The central bank has turned to targeted tools including relending and selective RRR cuts to
optimize China's credit structure. It will also continue to expand the list of available tools,
including short-term liquidity operations (SLO), and standing lending facilities (SLF),as well
as weekly open-market operations and bond sales (see Interest-rate liberalization to
complete in 2 years, 10 July).
On 23 July, the State Council pledged to launch “decisive measures” to support reasonable
credit growth, and promised to control the unreasonable increase of fund-raising cost, raise
the size of its "re-lending" and "re-discount" programmes to accelerate the supply of funds to
SMEs, and promote direct financing — especially the range of financing channels available
to SMEs. In our view, it will continue to be the engine for economic growth in 2H14 (see
Flash PMI shows impact of mini-stimulus, 24 July).
While the report made no mention of pledged supplementary lending (PSL), it did say that
the bank would “deepen reform” of the China Development Bank (CDB) to support
shantytown redevelopment and city infrastructure. It suggests that the CDB’s role in
conducting PBoC’s discretionary policy will become more important in 2H14 (see PSL:
Innovation or setback to China’s monetary-policy reform? 23 July).
Beyond targeted measures: structural reforms
We maintain that the economy is heading to a growth rebound with the monetary easing.
Specifically, the rebound is built upon significant fiscal investments financed by statesanctioned credit, as part of the mini-stimulus since early April (see Growth outlook improves
thanks to mini-stimulus, 16 July). More measures have already been unveiled at local
government level to support the property market.
61
Economics Update
In the report, the PBoC noted that monetary policy is generally broad reaching, while the
targeted measures are supplementary, they are not sustainable. According to the PBoC, this
is because these tools undermine the effectiveness of the market in allocation of resources.
In the long term, the credit system needs to be optimized through system liberalization and
structural upgrades to increase the role of the market.
Therefore, the PBoC pledged to maintain its easing bias while continuing to launch muchneeded structural reforms. It will adopt various quantity-based tools and price-based tools to
adjust its policy position. The central bank will also ensure that the banking sector enforces
adequate liquidity and asset management to control risk and expand its role in supporting the
real economy.
A key area of reform highlighted in the report was the renminbi exchange-rate formation
system. In 1H14, the renminbi peaked at CNY6.04:USD1.00 and troughed at
CNY6.26:USD1.00, reflecting considerable expansion of its trading range. Going forward, we
expect economic conditions to become favorable for mild renminbi appreciation in 2H14,
thanks to: 1) the mini stimulus helping improve economic conditions; 2) returning global
appetite for Chinese investment; and 3) still-high interest rates in the Chinese market. We
expect the trading band will likely expand further, and to appreciate mildly in 2H14 to reach
CNY6.05 to 6.10 to the US dollar by end-2014 (see Expecting a stronger Renminbi in 2H14,
28 July).
Fig 69 Monetary easing is evident in 2Q14
1,400
20
18
1,200
16
800
12
CNYbn
14
10
600
8
400
6
YoY%
1,000
4
200
2
0
Jun-11
Jun-12
New loan
0
Jun-14
Jun-13
M2 (RHS)
M1 (RHS)
Source: CEIC, Mizuho research
Fig 70 Interest rate started to drop in 2Q14
16
9.0
14
8.5
12
8.0
7.5
7.0
8
6.5
6
6.0
4
5.5
2
5.0
0
4.5
-2
Jun-09
Jun-10
Jun-11
Effective rate
Jun-12
Jun-13
Weighted average lending rate (RHS)
Source: CEIC, Mizuho research
62
4.0
Jun-14
%
%
10
Economics Update
Fig 71 In 2H14, policymakers need to support housing market through mortgage lending
Hom e price change from previous month
70
Number of cities
60
50
40
30
20
10
0
Jun-11
Dec-11
Jun-12
Dec-12
Up
Jun-13
Unchanged
Dec-13
Jun-14
Down
Source: CEIC, Mizuho research
Fig 72 We maintain that mild renminbi appreciation is likely in 2H14
CNY/USD
6.30
6.25
6.20
6.15
6.10
6.05
6.00
Jul-13
Sep-13
Nov-13
Jan-14
Fixing
Source: CEIC, Mizuho research
63
Mar-14
Spot
May-14
Jul-14
Economics Update
23 July 2014
PSL: Innovation or setback to China’s
monetary-policy reform?
 The PBoC will provide CNY1t over the next three years to the China Development
Bank (CDB) for re-lending for reconstruction of shantytowns. The funding is
channelled through Pledged Supplementary Lending (PSL), a new tool.
 In our view, while PSL is a more effective targeted measure for lending to specific
sectors, it lacks the transparency, scale, and market participation to become an
effective tool under China’s financial market liberalization. It also fails to give
effective guidance on the market’s medium-term interest rate.
 In any case, we consider the PSL a sign of further monetary policy easing that is
probably more powerful impact than RRR cuts. But we still believe that the PBoC
needs to return to traditional monetary policy such as RRR cuts and open-market
operations to support fiscal-driven investment spending to boost the resilience
of 2H14 growth.
CNY1t in PSL for housing reconstruction
Caixin reported that the PBoC has provided CNY1t to the China Development Bank (CDB)
for re-lending for the reconstruction of shantytowns. The funding is channelled through a new
monetary tool called "Pledged Supplementary Lending" (PSL). As previewed by PBoC
governor Zhou Xiaochuan, the PSL is backed by collateral, and it resembles the central
bank’s existing relending facility (see Interest-rate liberalization to complete in 2 years, 10
July). This is the first publicized use of PSL.
The PSL will be dispensed over a three-year period and allocated to the housing finance
department of CDB. The PBoC will use this method to provide targeted support to projects
such as promoting affordable housing construction. The PBoC’s previous re-lending
arrangements have generally been for less than one-year. The three-year PSL, in our view,
may also follow similar arrangement that break the CNY1t down into CNY330b liquidity per
year on average over the next three years.
A new generation of monetary policy in China
We consider the collateral requirement notable progress in China’s monetary policy. The relending arrangement that the PBoC has adopted so far has had significant moral hazard
problems, as the effectiveness of targeted lending depends on the banking sector’s
willingness to enforce guidelines. The PSL, in comparison, may allow bank lending to
targeted economic sectors as collateral. It allows the PBoC to provide feedback on bank
loans and adjust credit supply based on loan destination.
Under the PSL, the CDB must provide affordable loans to support economic growth in
specific sectors in the economy. As the return on such loans could be limited by policy
guidance and lending risk, funding from the PSL also must be low-cost. In fact, media reports
say that interest rates charged by the PBoC will be around 4% — less than the average CDB
funding cost. Through this framework, the PBoC also plans to provide guidance on mediumterm interest rates to the market.
A step back in China’s financial system liberalization
The PSL reflects the government’s effort to step up monetary easing to finance fiscal-driven
investment projects, which has been the underlying driver for more resilient growth in 2Q14
and beyond. In fact, it is probably more powerful than RRR cuts. With this, we maintain our
64
Economics Update
view that China’s monetary easing is accelerating and that this should lead to further fiscalinvestment spending and economic growth that is more resilient in 3Q14.
However, we also think that policy experiments such as PSL showed that the PBoC is
moving away from traditional monetary-policy tools such as RRR and open-market
operations. We maintain that these new tools should not be preferred to traditional tools, as
they: 1) lack transparency and market participation; 2) are a step back in China’s financial
marketization; 3) are a misuse of the PBoC’s mechanisms; and 4) they confuse the role of
other government departments (see The PBoC’s confused monetary policy, 28 May). For
example, we do not know if the PBoC has conducted PSL in the past, as they have not been
publicized.
In our view, the lack of transparency, scale, and market participation suggests that the
PBoC’s plan to use PSL to guide market-interest rates will be futile. Instead, we maintain that
the government should expand RRR cuts to all major banks, along with increasing market
transparency as a part of interest rate liberalization (see Interest-rate liberalization to
complete in 2 years, 10 July).
Fig 73 We maintain that further RRR cuts are necessary
Required reserve ratio
23
21
19
%
17
15
13
11
9
7
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Large financial institutions
Small and medium-sized financial institutions
Source: CEIC, Mizuho research
65
Jun-10
Jun-11
Jun-12
Rural cooperatives
Rural commercial banks
Jun-13
Jun-14
China macro monitor
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66
China macro monitor
Recommendation History
Company name (ticker)
Date of
recommendation
Recommendation
Previous close
(local currency)
Relevant disclosure
1
Note: NR = Not Rated. Source: MHSC Group
Important Disclosure Information
Note 1: Where “disclosure date” appears below, this means the day prior to the report date for securities listed on the Hong Kong Stock Exchange. For all other securities,
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Distribution of rating of companies covered by Mizuho Securities Asia Ltd.
Rating matrix
Distribution of ratings*(%)
Investment banking relationship**(%)
BUY
51.6
9.4
NEUTRAL
36.3
2.2
UNDERPERFORM
12.1
13.3
Note *: Distribution of rating on all companies covered by Mizuho Securities Asia Ltd.
Note **: Percentage of companies within each rating category receiving investment banking services from Mizuho Securities Asia Ltd in the past 12 months.
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Mizuho Securities Asia Limited ratings are based on the following definitions.
Ratings and price objectives are based on returns expected over the next 6-12 months.
BUY
Stocks for which our price objective, as of the date it is set, exceeds the share price by 10% or more as of the date of the rating.
NEUTRAL
Stocks for which our price objective, as of the date it is set, is within 10% of the share price as of the date of the rating.
UNDERPERFORM
Stocks for which our price objective, as of the date it is set, is below the share price by 10% or more as of the date of the rating, and/or which are
expected to be among the stocks that provide lower investment returns than stocks within their respective coverage groups that have “BUY” or
“NEUTRAL” ratings.
RS
RATING SUSPENDED – rating and price objective temporarily suspended.
NR
No Rating – not covered, and therefore not assigned a rating.
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67
China macro monitor
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68
Mizuho Securities Asia Ltd
August 2013
Mizuho Securities Asia Ltd
Mizuho Securities Asia Ltd
Telecommunications & Internet
Telescope: Realigning the future
Mizuho Securities Asia Ltd
Banks
Banks
Looking for the
silver bullet
Put your money
on the red
China Property
A developer for
life-cycle housing needs
SINA (SINA US)
Far EasTone (4904 TT)
Chunghwa Telecom (2412 TT)
Taiwan Mobile (3045 TT)
Tencent (700 HK)
China Telecom (728 HK)
HKT Trust (6823 HK)
Baidu (BIDU US)
September 2013
COMPANIES FEATURED
China Mobile (941 HK)
China Unicom (762 HK)
James Antos
[email protected]
+852 2685 2287
James Antos
Marvin Lo
[email protected]
+852 2685 2287
[email protected]
+852 2685 2031
RATING
DBS Group Holdings (DBS SP)
BUY
Oversea-Chinese Banking Corporation (OCBC SP) NEUTRAL
United Overseas Bank (UOB SP)
NEUTRAL
Bank of East Asia (23 HK)
NEUTRAL
Bank of China (Hong Kong) (2388 HK)
BUY
Hang Seng Bank (11 HK)
NEUTRAL
Wing Hang Bank (302 HK)
NEUTRAL
HSBC Holdings Plc (5 HK)
NEUTRAL
Standard Chartered Bank (2888 HK)
NEUTRAL
PO
SGD19.0
SGD10.0
SGD23.0
HKD30.0
HKD30.0
HKD114.0
HKD133.0
HKD90.0
HKD200.0
Please refer to pages 38 – 40 of this report for important disclosure and analyst certification information.
Please refer to pages 82– 84 of this report for important disclosure and analyst certification information.
Sino-Ocean Land
(3377 HK)
Alan Jin,
PhD, CFA
[email protected]
+852 2685 2018
BUY
PO HKD6.05
Please refer to pages 27 – 28 of this report for important disclosure and analyst certification information.
Please refer to pages 38 – 40 of this report for important disclosure and analyst certification information.
FEAT
URED
www.mizuho-sc.com/hk
[email protected]
ANA
LYST
Jianguang Shen
Charles Park
James Antos
Chief Economist
Technology Research
Banking Research
[email protected]
+852 2685 2022
[email protected]
+852 2685 2028
[email protected]
+852 2685 2287
[email protected]
+852 2685 2275
Marvin Lo
Alan Jin, PhD, CFA
Telecoms Research
Andrew Chan
Ole Hui
Property Research
[email protected]
+852 2685 2031
Oil & Gas Research
[email protected]
+852 2685 2018
Autos & Industrials Research
[email protected]
+852 2685 2082
[email protected]
+852 2685 2036
Peter Tang
Consumer Research
FEAT
URED
ANA
LYST
Kengo Yoshida
Jeremy Yeo
Jin Yoon
Michael Luk
Strategy Research
Consumer Staples Research
Internet Research
Economic Research
[email protected]
+852 2685 2425
[email protected]
+852 2685 2083
[email protected]
+852 2685 2278
[email protected]
+852 2685 2155
Ken Ma
Chris Yim
Kevin Chen
Thomas Zhang
Oil & Gas Research
Technology Research
Technology Research
Autos & Industrials Research
ken [email protected]
+852 2685 2067
[email protected]
+852 2685 2032
[email protected]
+852 2685 2035
thomas.zhang @hk.mizuho-sc.com
+852 2685 2034
HONG KONG
Mizuho Securities Asia Ltd.
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