China central bank cuts rates

28 Jun 2015 | Author: | No comments yet »

A little love from central mama.

China’s battered stock market may be in for a respite from the forced sales that culminated on Friday in the biggest sell-off in seven years, when investors begin trading today buoyed by Beijing’s double-barrelled cuts to interest rates and banks’ required reserves. BEIJING: China’s central bank said Saturday it would again reduce interest rates by 25 basis points, its fourth such cut since November as it tries to boost growth.

After Chinese stocks cratered Friday—the culmination of a 10-trading-day run that erased nearly a fifth of the stock market’s value—China’s central bank sprang a surprise quarter-point interest rate cut along with a loosening of bank reserve requirements Saturday.Spoiled by the easy riches delivered by a 60% rally since the start of the year, China’s growing swarm of the retail traders have looked more and more like petulant brats with their demands that Beijing open the monetary policy spigot ever wider to sustain what many have come to believe is a perpetual money making machine offered by the nation’s stock markets. Francis Lun Sheung-nim, the chief executive of GEO Securities, said a brutal sell-off on the back of an unwinding of the huge margin financing extended by brokerages to their clients for stock trading in the past two months – fuelling a 34 per cent surge in the Shanghai Composite Index – had seen the benchmark return to a more sustainable level. The benchmark interest rate would be reduced to 4.85 per cent and the deposit rate to 2 per cent from Sunday, the People’s Bank of China (PBoC) said on its website.

While most assumed the government found great virtue in the bull market to help companies raise capital and deleverage balance sheets, Saturday’s move removes whatever pretense some may have had that market forces were the main driver of Chinese stocks. Saturday’s combined easing highlights Beijing’s concerns that money isn’t flowing to some of the most-needed sectors in the economy and that stubbornly high borrowing costs that could fuel bankruptcies and job losses. The PBoC also announced that it will cut the reserve requirement ratios (RRR) by 50 basis points for commercial banks serving rural areas, agriculture and small businesses.

Lun said that after the latest easing measures, the Shanghai market should see strong support at the 4,000-point level and stage a rebound, provided the forced sale of stocks backed by margin financing was cleared. The PBoC has now cut interest rates four times since November and this year also reduced the amount of cash banks must keep in reserve three times, as well as using other measures to inject liquidity into the market. However, heightened concerns over the risk of Greece defaulting on a €1.6 billion (HK$13.85 billion) repayment to the International Monetary Fund could raise short-term borrowing costs in Europe. “I expect the Hang Seng Index to first fall some 200 points in reaction to the messy situation in Greece,” Lun said. “If the unwinding of margin financing pauses and the mainland markets rebound, then we may see Hong Kong stocks recover later.” The Shenzhen market’s 20 per cent drop from its June 12 peak means it is officially in a bear market. The bank said the latest moves were aimed at “stabilising growth” and “to further enhance the efficiency of monetary policy to (support) economic transformations” and are similar to cuts made last month.

Some government economists have been calling for interest rate cuts to help lower real borrowing costs and help local governments to swap their maturing debt, although some private sector analysts have recently pared their expectations on policy easing. China’s economic growth has slowed, with gross domestic product (GDP) expanding at 7.4 per cent in 2014, the lowest rate in 24 years, prompting the central bank to intervene. Despite the drumroll of rate cuts, the real cost of borrowing in China remains stubbornly high, due in part to cooling inflation and banks’ reluctance to pass lower rates on to their customers. While the timing of the rate cut makes it look like the PBoC’s hand was forced by the monkey hammering dealt out to stocks on Friday, the rate cut allows Zhou to unleash what ANZ calls the “one stone, two birds” effect: a boost to market confidence and a boost for growth.

On Friday Chinese stocks plunged with Shanghai dropping 8.5 per cent at one point, its biggest loss in eight years, as investors that had flooded the market on margin trading — borrowing cash to buy stocks — ran for the door. Think of it as the Zhou Put, similar to the Greenspan Put, the bubble-inducing monetary policy approach favored by former Federal Reserve chairman Alan Greenspan that ultimately didn’t work out that great for the U.S. economy and Wall Street. It lowered reserve requirement for finance companies by 300 basis points, which it said will help ease funding and costs pressure on state-owned enterprises. The country’s economy expanded 7 per cent year-on-year in the first quarter, slumping to a post global financial crisis low, even as Beijing took steps to bolster growth.

Weighed down by a property downturn, factory overcapacity and local debt, growth in China’s economy is expected to slow to a quarter-century low of around 7 percent this year. Meanwhile, the consumer price index fell to a year-on-year pace of 1.2% in May, while deflation continues to haunt wholesale prices as the Producer Price Index added to the run of data that has been on a deflationary path since March 2012. It said the level of cash in the financial system was “quite abundant” at the moment, noting that banks have 3 trillion yuan in excess reserves and that overnight lending rates are just about 1%, near historic lows. The government has cut the annual growth target for 2015 to “approximately” seven per cent. “The improvement in economic growth momentum is still fragile,” Yang Zhao, Hong Kong-based chief China economist at Nomura Holdings, wrote in a June 26 note. “Share market sentiment has cooled.”

Given how poorly supported stocks are by the fundamentals, and given how much margin leverage is embedded in investors’ positions, withdrawal of state support will give a shock that could prove calamitous. Beijing can make policy as accommodative as it likes but the reality is that banks, the transmission mechanism for monetary policy, don’t want to lend.

Who could blame a banker for not wanting to extend loans when he or she knows the conditions on the ground include companies struggling under the weight of too much debt, squeezed margins and crimped cash flow. Analysts said Saturday’s cut in the RRR to only selected highlights authorities’ concern that the easing so far has mainly fueled speculation in the stock market, and the impact on the overall economy remains limited. “Speculation in the stock market is decreasing which has helped remove obstacles for policy loosening. While the one-two policy punch delivered on the weekend will bolster confidence, does it mean investors should be jumping into China’s stock market?

For a comprehensive analysis of the risks posed by the margin finance, IPOs and share placements, please read the weekend piece by my colleague Isabella Zhong. Even that number if flattered by the inclusion of the depressed valuations of financials, with the broader market excluding financials trading at a dizzying 41 times earnings.

But Shanghai looks like a veritable bargain compared to the Shenzhen market, which trades at 60 times, and the ChiNext, or China’s version of the Nasdaq which trades at a stratospheric 130 times earnings! Yes, the government is pursuing a reform agenda that could deliver a new phase of growth for China’s economy by allowing market forces to play a “decisive” role in the allocation of resources. Yes, encouraging greater participation in stocks is also good but not if rampant speculation is allowed, threatening people’s wealth and financial stability in an economy and banking system already stressed by a major debt hangover.

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