Chinese interest rates a vote for liberalisation
‘Liquidity will be kept at reasonable volumes to maintain the reasonable growth of money, credit, and all-system financing aggregates, and to create a neutral and appropriate monetary and financial environment for structural adjustment, transformation and upgrading of the growth pattern.’
People’s Bank of China (PBoC), 23 January 2015
A lot of attention has been paid to the 0.25% cuts in China’s one-year benchmark loan and deposit interest rates last month. Coming soon after the surprisingly low inflation data for January (CPI 0.8%, PPI -4.3%), the assumption has generally been that Chinese policymakers, seeing the threat of deflation, acted to cut interest rates to stimulate the economy.
While monetary stimulus may follow in China in 2015, we believe these interest rate cuts represent something different.
Firstly, the PBoC has only recently stated (above) that monetary policy will be kept at neutral for the time being, with the focus instead on improving the quality and sustainability of economic growth.
Secondly, the combination of loan-deposit ratio limits for borrowers, high deposit reserve ratios for institutions and formal lending quotas means that the major policy control for monetary policy is not interest rates.
Finally, at several points in the recent past, China has had negative inflation and policymakers have only reacted strongly when the economic growth rate seemed imperilled.
Instead, we think the interest rate cut signifies ongoing reform of the financial system. Why? Along with the rate cut, the ceiling that determines the maximum bank deposit rate was increased.
By liberalising the ceiling, the PBoC is moving the system towards market-based deposit rates (a precursor to full interest rate liberalisation).
When a similar move happened in the fourth quarter of last year, the large banks with excess deposits were able to protect their net interest margins following the benchmark deposit rate while smaller/ weaker banks facing deposit stresses chose to follow the ceiling rate.
We believe that the reform process in China has significant momentum and the PBoC continues to be a champion of reforms for the financial system.
High real interest rates in China will allow policymakers to ease should growth slow excessively, but we think the November and March rate cuts represent slow but steady interest rate liberalisation.
We remain positive on the outlook for the Chinese economy and for Chinese equities, which remain among the cheapest in the world.
J O Hambro is our London-based investment boutique with equities capabilities across the UK, Europe, Asia, as well as Developed and Emerging Markets. James is one of the managers of our Global Emerging Markets Opportunities Fund.