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China – reforms to monetary policy, an attempt to ease the pain

  • People’s Bank of China (PBOC) makes changes to the lending rule-book
  • Changes to the way commercial lenders set interest rates expected to make borrowing cheaper and easier
  • Intended to give the slowing economy a boost
  • More protection against US tariffs as unresolved trade war continues to pose a threat

Weakening economic growth is causing concern among the Chinese administration. The latest policy adjustment – intended to spur on growth – relates to the way commercial lenders set interest rates on the loans they provide to the business community. The reforms come at a time when the global markets look vulnerable.

S&P 500 – Year to date price chart:

Source: TradingView

 

Moving targets

China’s growth rate of approximately 6% per annum is still the stand-out figure in the global league tables. Moving away from the absolute number, the concern now is that the projected growth for 2019 might miss the International Monetary Fund (IMF) target rate of 6.2%. US tariffs are due to come into place on Chinese exported goods in September and December, and would be readily used by the US administration to explain China missing the 6.2% target. The fact that there are other factors at play, such as a weakening eurozone economy, could be easily overlooked, and the US and Chinese instead trade barbed comments on ‘who’s hurting the most.’

 

Something to ease the pain

On Tuesday, CNN reported on JPMorgan, which has increased its estimation of the costs to the US consumer:

“The tariffs Trump has already imposed on China are estimated to cost the average American household $600 per year, according to a report by JPMorgan Chase. That will rise to $1,000 if Trump carries through on his plan to levy tariffs on another $300bn of US imports from China.”

Source: CNN Business

If this monetary value is an appropriate index of the ‘pain’ suffered by the average American consumer, the hurt just got turned up by 66%. Those working in the agricultural sector – ranging from farmers in the mid-west to lobster fishermen in Maine – are in the front line of the trade war and would likely suggest their own situation is much worse than the one JPMorgan describes.

With the US applying tariffs of up to 25% on $300bn of Chinese goods, the drag on performance in 2020 could be more notable as the tariffs would apply across the whole 12 months. Currently, the IMF forecasts growth of 6.0% in 2020 but that calculation was made prior to the most recent escalation of the trade war when the US administration scaled up its offensive.

Trade wars don’t have ‘winners’ and the negative impact felt in the US is matched by a similar story developing in China. Industrial production in China grew just 4.8% in July, which was down from June’s reported figure of 6.3%.

Source: South China Morning Post

The metric used by China's National Bureau of Statistics measures output from the manufacturing, utilities and mining, sectors and shows the worst growth levels for that sector for more than 16 years. If the news wasn’t bad enough, there is also the additional element of surprise to consider. A poll by Reuters established that market analysts had thought July’s growth would be 5.8%. Such a big miss is just the sort of thing to spook the markets.

Source: South China Morning Post

The poor ‘factory gate’ numbers are a good leading indicator of future performance, but the slowdown is already being reported at the other end of the production cycle. Retail sales in July also missed. July growth was 7.6% down from 9.8% growth in June.

 

How it works

Monetary policy is done differently in China. The PBOC has a range of monetary tools to control money supply and interest rates. Referencing ‘rates’ as plural rather than singular is intentional as unlike most western central banks, there is more than one. The Loan Prime Rate (LPR) reflects what chosen domestic lenders charge their most creditworthy borrowers. It is significant because it is the rate that is charged to the best grade of borrower. In effect, it has over time become the unofficial minimum interest rate.

The recent news out of China is that the PBOC is restructuring the LPR system to allow more end users access to cheaper borrowing.

  • Lenders will be encouraged to price new loans using the lower LPR rate instead of the standard benchmark rate.
  • The number of lenders will be increased from 10 to 18, with plans to further increase the pool of lenders.
  • The 18 selected lenders is set to include a mix of domestic and international names including Citigroup and Standard Chartered.
  • Domestic banks such as rural commercial banks and private banks are to be included in the pool of lenders.
  • Rates will be fixed on the 20thday of the month rather than daily. Tuesday 20thAugust marked the first date when PBOC calculated the average LPR among lenders and broadcast that as the market benchmark to be used through the next month.
  • The LPR will itself face downward pressure as the PBOC will link it to the lower Medium-term Lending Facility (MLF) rate.

All these changes should increase lending to those sectors of the economy that need it most. Reputable manufacturers have for some time been squeezed by the banks’ desire to protect their own profit margins. The PBOC will also hope that moving the lowest rate down will see other lending rates head in the same direction.

 

So far, so good

There has already been some downward movement in rates. The August fixing of LPR rates took place on Tuesday and the new one-year loan prime rate was set at 4.25% – down from 4.31% previously. The five-year loan prime rate was fixed at 4.85%, which comes in below the five-year benchmark rate of 4.9%.

Shuang Ding, chief Greater China economist of Standard Chartered Bank, said:

“The important thing is that the central bank will have more policy choices after the mechanism is established.”

Source: South China Morning Post

The reduction in rates will be welcomed, but the Chinese administration will take far greater comfort in establishing a proof of concept. The PBOC may also raise a smile at being given a greater degree of independence from Beijing.