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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 This page is intentionally blank. 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, it means the end of the month preceding the date of this report, unless that month end is within 10 calendar days of the report date in which case the disclosure date is the end of the preceding month. 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This document may not be altered, reproduced or redistributed, or passed on to any other party, in whole or in part, without the prior written consent of Mizuho Securities Asia Limited. 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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