China rate reforms set to reduce borrowing costs

Move aims to support businesses hurt by weak demand at home and trade war with US

BEIJING • China's announcement of key interest rate reforms over the weekend fuelled expectations of an imminent reduction in corporate borrowing costs in the struggling economy, boosting share prices yesterday.

The People's Bank of China (PBOC) unveiled the long-awaited reforms last Saturday to help steer borrowing costs lower, and support businesses hurt by weak demand at home and a year-long trade war with the United States.

From today, new loans must be priced "mainly" with reference to a revamped benchmark that tracks the price of credit to banks' best customers, the so-called Loan Prime Rate (LPR). In turn, that rate is linked to the price the PBOC charges lenders for cash over one year.

The changes push China's financial system further towards being truly market-led, and away from the communist-era command economy where officials set both the price and quantity of credit. By unifying market and official rates, the PBOC also intends to bring down the stubbornly high cost of borrowing, and aid pass-through of future changes in policy rates.

While the rate overhaul has been in the works for some time, the announcement came days after data showed the economy stumbled more sharply than expected last month, raising questions over whether more rapid and forceful stimulus may be needed.

Analysts believe the revamped LPR will be lower than the current level of 4.31 per cent, but they are divided over how much funding costs will come down and how quickly.

LOWERING COSTS

In the future, if the policy interest rate falls, the loan interest rate will also fall, which will help to reduce the financing cost of enterprises.

MR MA JUN, a policy adviser to the central bank, on the interest rate reforms.

While China has pushed plenty of liquidity into the financial system over the past year - to shore up growth and guide short-term rates down - loan demand and fresh investment have been relatively subdued amid weakening business confidence and banks' worries of more bad loans.

Under the new mechanism, bank lending rates will be linked to the LPR, which will be linked to the PBOC's medium-term lending facility interest rate, and that should establish a relatively smooth policy transmission mechanism, said Mr Ma Jun, a policy adviser to the central bank. "In the future, if the policy interest rate falls, the loan interest rate will also fall, which will help to reduce the financing cost of enterprises," he said in remarks published on the website of state radio yesterday.

China and Hong Kong stocks rose on expectations that the move will ease corporate financing pressures, but some analysts cautioned the reform may not be equivalent to cuts in bank's actual lending rates, as banks could still charge higher rates on riskier loans to smaller, private firms.

Still, Chinese banking shares fell amid worries of lower profitability for lenders. Reactions in the bond and yuan markets were muted.

"The new system itself doesn't guarantee the actual lending rate will be lower," Goldman Sachs said in a report. "But, given the current situation with weak activity growth, heightened trade war risks and a strong desire by the senior leadership to lower rates, we do expect actual lending rates to go down."

Australia and New Zealand Banking Group estimates that the reform is equivalent to making a 45 basis point loan rate cut.

Under the changes, banks must set rates on new loans using the new LPR as the benchmark for floating lending rates, rather than the PBOC's benchmark bank lending rate. The market's focus will be on where the new LPR is set today. Rates will be published on a monthly basis.

Banks will set rates on new loans by adding a spread to the new LPR reference rate, the central bank said.

But existing loans will still follow the original contracts that were signed in line with the benchmark lending rate. China's outstanding local-currency loans were at a staggering 147 trillion yuan (S$28.9 trillion) at the end of last month.

A massive 28 trillion yuan in long-term mortgage loans are exempt from the new scheme, analysts at Nomura note.

Mr Tommy Xie, an economist at OCBC Bank, said the move is a "half step" towards interest rate liberalisation, and the link to the medium-term lending rate may only be temporary. "The current liberalisation focuses only on the lending rate while the deposit rate was left untouched... In the longer run, China may also need to loosen the setting of the deposit rate."

REUTERS, BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on August 20, 2019, with the headline 'China rate reforms set to reduce borrowing costs'. Print Edition | Subscribe