THE biggest monthly drop in Chinese household deposits since at least 2007 is keeping borrowing costs for banks at a record high, adding pressure on policy makers to free up cash with a cut in reserve requirements.
Household deposits fell by 727.2 billion yuan (US$114 billion) in October and have declined 1.1 percent since June 30, central bank data show. That's caused financial institutions to raise the six-month cost for interbank lending by 20 basis points this quarter to 5.5 percent, the highest level since the data started in 2006, according to the National Interbank Funding Center in Shanghai.
China's policy makers are trying to balance goals of sustaining economic growth and protecting the savings of the 1.3 billion people. Inflation is 2 percentage points higher than the benchmark deposit rate, compared with 1.2 percentage points in India. Authorities will probably reduce bank reserve ratios early next year and leave benchmark rates unchanged, according to Barclays Capital and Credit Agricole CIB.
"China needs to cut the required reserve ratio to improve liquidity in the system, enabling banks to have more funds to lend out," said Shen Jianguang, an economist in Hong Kong at Mizuho Securities Asia Ltd, which expects a 3.5 percentage point cut in the reserve ratio to 18 percent next year. "Deposit outflow will remain an issue in China. The one-year deposit rate is currently 3.5 percent while the inflation rate is about 5.5 percent."
Lenders are still facing difficulty in offering loans as rising prices curtail deposits, China Merchants Bank Co President Ma Weihua said in Hong Kong on November 15.
Declared bankruptcy
The China Banking Regulatory Commission told banks last week to prepare to restructure the debt of unprofitable local government financing vehicles. More than 80 businessmen in Wenzhou City, Zhejiang Province, have disappeared, committed suicide or declared bankruptcy to avoid repaying debts to informal lenders since April, Xinhua news agency reported in September.
The world's second-largest economy needs to take steps to correct negative real interest rates, David Dollar, the United States Treasury's economic and financial emissary to China, said last week. Interest-rate controls in China cause economic problems because state-owned firms are subsidized and households are turning to shadow banking, Dollar said.
"Households are taking their money out of the banking system, trying to find out other investment opportunities," said Gao Bin, head of Asia-Pacific rates research at Bank of America Merrill Lynch in Hong Kong. "Deposit growth is troublesome and it hurts banks in terms of getting cheap funding."
China's sovereign bonds gained 0.9 percent this month, the second-best performers in an HSBC Holdings Plc index of Asian local-currency debt, on speculation the government will make more money available to banks. The nation's benchmark three-year bond yield fell 57 basis points, or 0.57 percentage point, to 3.14 percent this quarter and the 10-year yield dropped 22 basis points to 3.64 percent.
The yuan weakened 0.2 percent last week to 6.3554 percent on concern China's economy is slowing.
Premier Wen Jiabao said on October 25 that monetary policy will be "fine tuned," a turnaround after interest rates were increased five times since September 2010. Gross domestic product gained 9.1 percent in the third quarter, after averaging 10 percent growth over the past five years, official figures show. Inflation slowed to 5.5 percent in October from a three- year high of 6.5 percent in July.
Shibor rate
Interbank borrowing costs haven't declined even as the six-month People's Bank of China bill yield dropped 34 basis points this quarter to 3.30 percent. The Shibor rate isn't falling much as people are still waiting for more signs of monetary policy easing, said Shi Lei, head of fixed-income research in Beijing at Ping An Securities Co, a unit of the nation's second-biggest insurance company.
"While the cuts the PBOC made in bill rates helped Shibor to stall, the decline will be more significant when more easing signals appear," he said. "The government won't necessarily cut interest rates anytime soon unless something extreme happens externally. China has experienced a relatively long inflation cycle and it doesn't seem to be having a hard landing."
The costs of insuring China's banks against default have retreated from more than two-year highs on speculation looser monetary policy will limit bad loans. Credit-default swaps for Bank of China Ltd have fallen 76 basis points from 343 basis points on October 4, the highest level since March 2009. Swaps for China Development Bank Corp have slid 105 from 382 on October 4, a 31-month high.
The contract protecting sovereign bonds cost 151 basis points last Friday, according to CMA, which is owned by CME Group Inc and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.
"Monetary loosening measures can help improve loan quality and hence alleviate investors' concerns," said Stanley Li, an analyst in Hong Kong at Mirae Asset Securities (HK) Ltd. "CDS prices of Chinese banks may fall accordingly."
China's one-year deposit rate, currently at 3.5 percent, has remained below inflation since February last year. Consumer prices climbed 5.5 percent last month. The PBOC also boosted reserve requirement ratio nine times in the past year to 21.5 percent for large banks.
Liquidity tools
"China will refrain from cutting the policy rate from here and liquidity tools will be used to help the economy," said Wang Ju, a fixed-income strategist at Barclays Capital in Singapore. "The policy rate has been kept too low compared with inflation."
Barclay's Wang predicts authorities will cut the reserve ratio for the first time in four years in January because of the rising demand for cash during the Lunar New Year holiday that starts on January 23. The three-year bond yield will probably slide to 2.8 percent by the end of 2011 and the 10-year yield to 3.5 percent, she forecast.
Interest rates in China need to be more influenced by the market, according to a November 15 International Monetary Fund report. "Relatively low" rates have distorted investment and savings decisions, generating incentives to over-invest and suppressing household income through low returns on deposits, the report said.
Source:shanghaidaily