China easing tipped to boost onshore bonds

Monetary easing is likely for years to come in China following last week’s cut to the reserve requirement ratio (RRR) for banks, and there will be more interest rate cuts this year, argues a debt investment specialist.

RRR is the minimum level of reserves that banks are required to hold. China uses RRR as a monetary tool by increasing or decreasing it depending on whether it needs to stimulate or cool the economy. When banks are set a lower RRR, they have more free capital to lend out.

In addition, the move will benefit the mainland bond market, said Meng Xiaoning, fixed income portfolio manager at CSOP Asset Management, the Hong Kong-based joint venture of China Southern Asset Management. He was addressing last week’s Borrowers and Investors Forum organised by FinanceAsia and AsianInvestor.

The People’s Bank of China’s (PBoC) measures will boost onshore bond prices (and thus push down yields), he said. The bonds currently offer a far higher yield than their equivalents in the US, Japan and Germany; as a result mainland bond yields have ample room to fall without becoming unattractive from a return perspective.

Five-year Chinese government bonds were trading at 3.39% at the close of business on Monday this week, while the equivalent bonds in the US, Japan and Germany were at 1.5%, 0.108% and -0.45% respectively.

The PBoC cut the RRR by 50 basis points to 19.5% last Wednesday, which was the first such universal cut - meaning it applies to all banks in China - since May 2012. It came just months after the central bank reduced interest rates last November, cutting the one-year lending rate by 40bp to 5.6% and the one-year deposit rate by 25bp to 2.75%.

Last week the PBoC also announced an additional targeted RRR reduction of 50bp for urban commercial banks and regional rural commercial banks in an effort to support small enterprises. Economists estimate that the total RRR cuts will inject more than Rmb600 billion ($96 billion) of liquidity into the mainland banking system.

This has signalled the start of quantitative easing similar to that seen in the West in recent years, Meng said.

The RRR cuts were a response to capital outflows from China in the fourth quarter, which totalled $91.2 billion, the biggest quarterly outflow for 17 years, and typically tight liquidity in the banking system in the run-up to the lunar new year.

“It is reasonable to expect two to three interest rate cuts and three to four RRR cuts this year,” Meng said. He noted that more easing should be expected because it would take time for consumption to pick up, especially with declining economic growth and a low inflation rate.

Several economists agree that more easing is to come. Gao Ting, head of Asia-Pacific macroeconomics in the chief investment office at UBS Wealth Management, said he expected another RRR cut and one or two additional interest rate reductions in the next six months. Chang Jian, chief China economist at Barclays, expects two 25bp interest-rate cuts in the first half of 2015.

The last Chinese monetary easing moves occurred in the aftermath of the financial crisis in 2008, when a Rmb4 trillion stimulus package was announced. This time, however, the PBoC is using targeted stimulus policies rather than flooding the market with money, which had led to a property bubble and rising inflation, said Meng.

While Meng is optimistic about the mainland bond market’s future, he pointed out the difficulties that foreign investors have in accessing it, including that the numerous Chinese regulators all have their own rules.

The PBoC oversees the interbank bond market, where more than 95% of onshore bonds are traded. The State Administration of Foreign Exchange controls quotas for the renminbi qualified foreign institutional investor (RQFII) scheme. And the China Securities Regulatory Commission supervises the bond exchange market and the award of RQFII licences.

Overall, foreign investors held a total of Rmb672 billion in Chinese onshore bonds at the end of 2014, representing 2.24% of the Rmb30 trillion onshore bond market, according to the PBoC.