China rate cut fuels Asian equity rally

Singapore

CHINA'S unexpected interest rate cuts, its first in almost two years, provided the fuel for rallies in some Asian stock markets on Monday. But the bounce could be short-lived when the dust clears and investors are reminded the country's fundamentals are largely unchanged. (see infographic)

While Beijing's latest move stoked different interpretations among economists on whether it marked a change of course towards a loose monetary policy, most believe that the rate cut is buying time for China to tackle high funding costs, which could only be completely resolved through reforms.

Yesterday, the benchmark Shanghai Composite Index jumped 1.85 per cent or 46.09 points to 2,532.88 - its highest in three years, while Hong Kong's Hang Seng Index rose 1.95 per cent or 456.02 points to close at 23,893.14.

Chinese bonds also rallied, sending the 10-year government bond yield down by the most since 2008 to 3.53 per cent in Shanghai before edging back up to 3.63 per cent. The seven-day repurchase rate in the interbank market, a gauge of funding availability, fell 15 basis points to 3.51 per cent, according to a weighted average compiled by the National Interbank Funding Center.

The renminbi came under some pressure on Monday and weakened against the US dollar by 0.3 per cent to 6.1427, prompting most analysts to project more two-way volatility heading into next year.

Aimed at curbing stubbornly high borrowing costs, the People's Bank of China (PBOC) caught the market off-guard when it cut the one-year benchmark lending rates by 40 basis points to 5.6 per cent and lowered the one-year benchmark deposit rates by 25 basis points to 2.75 per cent with effect from Saturday.

Secondly, the central bank accelerated the pace of interest rate reforms by raising the deposit rate ceiling - the maximum range for commercial banks to set their deposit rates - to 20 per cent above benchmark deposit rate, up from the previous 10 per cent.

Some bankers note that the cut in lending rates may ease the financing costs of existing loans, but is unlikely to encourage banks to write new loans to lower-rung borrowers, as China's five largest banks still favour state-owned enterprises and those involved with large projects overseen by the government.

"It is not a sure-win bet that rate cut will bring down the funding costs completely," said OCBC economist Tommy Xie. "Indeed, the rate cut will benefit the existing loans. However, given the falling net interest margins (NIMs), banks may be reluctant to lower the funding costs significantly for new loans."

While some market watchers expect further targeted cuts in interest rates and reserve requirement ratios by Beijing next year; others believe that China has not changed tack.

Paul Gruenwald, Standard & Poor's chief economist, Asia-Pacific, noted that the rate cuts do not signal a renewed government intention to resort to aggressive stimulus to prop up the economy but rather "to smooth the process of economic adjustment by ensuring appropriate funding costs".

Given lagging performance of Chinese stock markets in recent years, Beijing's move has provided "a temporary boost to sentiment", analysts at Bank of America-Merrill Lynch observed.

But with excess manufacturing capacity, the real demand for credit will remain weak while growth and corporate earnings are likely to disappoint - all making a rally unsustainable, they said in a note. "The rate cut will largely send more liquidity into the property market again (as it did in 2012)." Economists flagged that the asymmetric cut on lending and deposit rates is likely to weigh on banks' net interest margin in the near term.

Should funding costs ease as hoped, the improved asset quality and the taming of non-performing loans may be able to offset the negative impact of declining NIM in the medium term, Mr Xie of OCBC said.

Credit Suisse research analyst Dong Tao noted that banks are fighting for deposits with the money market funds, and hence have limited space to lower deposit rates. This means that the direct impact on loan demand and economic growth should be limited as China is still in an early stage of de-leveraging.

If the rate cut turns out to mark the beginning of a rate-cut cycle, it will be a booster to the stock market, particularly shares of property companies. Yesterday, Poly Real Estate soared by its 10 per cent daily limit to 6.47 yuan in Shanghai while Vanke shot up 8.32 per cent to 10.15 yuan in Shenzhen.

But overseas property companies with large exposure to China, such as those in Singapore, are not expected to receive a lift from Beijing's latest rate cuts, unless there is a real improvement in the property market in China, said CIMB research head Kenneth Ng.

Unmoved by the strong leads from China and Europe where the central bank is widely expected to announce some stimulus, the Singapore stock market succumbed to profit-taking on Monday, with the benchmark ST Index down 4.79 points, or 0.14 per cent, to close at 3,340.53.

Deutsche Bank strategist Linan Liu said she expects China to establish a deposit insurance scheme before the end of this year.

"We believe the above measures will pave the way for PBOC to eventually abolish the policy deposit rate curve and policy lending rate curve, which we expect in late 2015. By then, the prime rate curve will develop into a market-based lending rates curve, and the policy deposit rate curve will be replaced with a short-term policy rate target, either the overnight rate or the seven-day rate," she said. "China is likely to complete its interest rate liberalisation reform towards the end of 2016."

*China's rate cut won't have desired effect