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China interbank rates dive after PBOC eases monetary policy

State-owned banks told to buy local-government debt, but the lenders consider the cost to be too high
Tuesday, May 26, 2015 - 05:50
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China's CSI 300 Index has topped the 5,000 level for the first time in seven years amid speculation that the government will accelerate stimulus measures to bolster the economy.

Beijing

INTERBANK market rates in China are dropping sharply as the country's central bank eases monetary policy and lenders are under pressure to buy debts from local governments.

The three-month Shanghai interbank offered rate (Shibor) has dropped 200 basis points since March 31 and is heading for the biggest two-month fall since 2008.

The drop comes after the People's Bank of China (PBOC) cut interest rates and reserve-ratio rates twice since the beginning of the year. More cuts are expected in the next two quarters as the government tries to shore up growth, which is falling to its slowest rate in 25 years.

Speculation that the government will accelerate stimulus measures to bolster the economy sent China's CSI 300 Index above the 5,000 level for the first time in seven years. The CSI 300, representing the largest stocks in Shanghai and Shenzhen, jumped 3 per cent to 5,099.84 at the close.

The fall of interbank market rates also comes on the heels of a massive debt swap between local governments and banks initiated by the central government earlier this month, and analysts say the rate can fall further as the central bank continues to keep liquidity conditions loose.

"There is adequate scope for the three-month Shibor rate to fall further as it is often used as the floating rate for loans and has lagged the sharp drop in the seven-day repo rate. It is still too early to expect the conclusion of the current easing cycle," HSBC analyst Andre de Sliva said earlier this month.

Three-month Shibor has fallen to 2.9 per cent from 4.9 per cent at the end of the first quarter. The central bank has shown no sign of stopping the slide. The seven-day repurchase rate averaged 2.18 per cent this month and 2.87 per cent in April, down from 4.49 per cent in March.

Initially, the programme to offload debts worth some one trillion yuan (S$216 billion) from local governments' balances sheets was due in April and was to be market driven. But banks were reticent to buy debt they considered at too high a cost: There is typically a time lapse before interest rate cuts trickle to the interbank market.

On May 8, the Ministry of Finance, PBOC and the securities regulator re-instigated the programme, this time specifically asking state-owned banks to buy the bonds.

Under the current plan, 36 regional and city governments across China are to offload part of their debts and 70-80 per cent of them will be bought by state banks in state-directed private placements. Interbank rates are expected to remain low throughout the whole programme.

Local governments can exchange some of their existing debt into bonds, in addition to selling bonds publicly in the interbank market and use the proceeds to repay loans.

Every new bond's interest rate must be no less than equal to the previous five days' average yield on bonds issued by the central government. The rate's high end is capped at no more than 30 per cent above that five-day average.

"The directive highlights that banks remain subject to direct influence from the authorities. It also suggests that propping up growth in the short term has temporarily taken priority over efforts to resolve solvency problems at the local government level," Fitch Ratings said in a comment on the plan.

"The latest directives could reflect a continuation of an 'extend and pretend' approach to the issue," the agency added.

Local governments are likely saddled with more than 18 trillion yuan worth of debt, according to an audit in 2013. Some 1.86 trillion yuan of that is expected to come due this year. But in reality the scope of the debt is unclear as much of it was offloaded on to "local government financing vehicles".

Fitch estimates local government debt to have reached 32 per cent of gross domestic product at the end of 2014, up from 18 per cent at end-2008.

Jiangsu was the first province to sell some 64.8 billion yuan in bonds. Xinjiang followed, selling 5.9 billion yuan worth of bonds.

While the plan is good news for the local governments that can restructure their debts in a more transparent way and lighten their cost interest, the banks' view is not as positive.

"Banks will receive lower yields on the same exposure at a time when net interest margins are coming under pressure owing to the macroeconomic slowdown," Fitch said.

Annual returns on these bonds are expected to be in the 4-5 per cent range, far below the 7-8 per cent in interest on existing loans to local government financing platforms.

It is not rare for Chinese state-owned enterprises (SOEs) to play the role of social stabilisers.

Earlier this month, SOEs which are witnessing slower activity were asked not to layoff workers.

Analysts say these bonds will be easier to sell now to other investors as they are implicitly backed by the Chinese government.

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