Swap Rates Tumble on Bets for Reserve-Ratio Cut: China Credit

The cost of fixing interest rates in China dropped to a one-year low on speculation policy makers will relax credit curbs that threaten to worsen a manufacturing downturn and labor unrest.

The two-year swap contract, the fixed rate that can be exchanged for the floating seven-day repurchase rate, fell as low as 2.79 percent yesterday, from a record 4.34 percent on Aug. 30, according to data compiled by Bloomberg. Similar swaps in India and Russia rose in that time, while Brazil’s declined.

China’s central bank lowered reserve-requirement ratios for more than 20 rural cooperative lenders this week, freeing up cash for factory owners to borrow as Europe’s debt crisis damps orders and workers demand higher wages. In the city of Wenzhou in Zhejiang province, more than 90 businessmen have fled and two committed suicide since April after the credit squeeze left them unable to pay debts and vulnerable to informal lenders charging punitive interest rates, according to a local business group.

Monetary policy has been overly tight and a continuation would make it harder for small companies to survive,” said Zhou Dewen, head of Wenzhou’s SME Business Development and Promotion Association, which represents small and medium-sized enterprises. “Record reserve-requirement ratios are to blame.”

Zhou predicts banks’ reserve-requirement ratios will be reduced nationwide by as much as a percentage point in December, after nine half-point increases since September 2010 that were aimed at cooling inflation. Standard Chartered Plc predicts a half-point cut next month. Analysts at Bank of America Corp., Citic Securities Co., ING Groep NV, Nomura Holdings Inc. and Societe Generale SA forecast the first reduction since 2008 will come before the end of March.

Strike Action

“High financing costs are a very big headache for many businesses,” said Huang Jifa, a deputy general manager in the investment banking arm of Beijing-based Industrial and Commercial Bank of China Ltd., the world’s largest bank by market value. He predicts reserve-requirement ratios will be cut in January.

The ratio for major banks was last increased in June, boosting it to a record 21.50 percent. The ratio for smaller banks stands at 19.50 percent. Inflation (CNCPIYOY) reached a three-year high of 6.5 percent in July, before slowing to 5.5 percent by October, official figures show. That’s still above the government’s 4 percent target, fueling demands for higher pay.

In Shenzhen, 1,000 workers went on strike Nov. 22 at a factory owned by a Taiwanese computer-parts maker after the company required staff to work overtime from 6 p.m. to midnight, New York-based China Labor Watch said in a statement. A day earlier, workers at a Shenzhen factory owned by lingerie-maker Top Form International Ltd. (333) struck over wages and unachievable production quotas, the group reported. Last week, 7,000 workers at a shoe factory in Dongguan walked out, the Hong Kong-based China Labor Bulletin reported.

Slowdown Signs

China’s manufacturing may contract this month by the most in almost three years, a preliminary purchasing managers’ index showed this week. Industrial output rose 13.2 percent from a year earlier in October, the least in 12 months, official figures show. Exports (CNFREXPY) rose 15.9 percent in October, the least in almost two years, and third-quarter economic growth of 9.1 percent was the slowest since 2009.

“An unbalanced recovery is better than a balanced recession,” Vice Premier Wang Qishan said Nov. 21 in Chengdu, pledging to support growth. The central bank said this week it will continue to implement prudent monetary policy, promote “reasonable growth” in credit and money supply, and guide financial institutions to increase support to rural areas and small companies.

Yuan Retreat

The People’s Bank of China set its reference rate for the yuan at 6.3554 per dollar, up from a one-month low of 6.3570 announced yesterday. The currency, which is allowed to trade as much as 0.5 percent on either side of the fixing, fell 0.02 percent today to 6.3694 as of 11:24 a.m. in Shanghai. This week’s 0.22 percent loss is the biggest drop in 10 months. Five-year credit-default swap contracts on China’s bonds were little changed yesterday at 165 basis points, CMA prices show.

“There’s strong loan demand from rural companies and small businesses, but we can’t meet all of it,” said a banker at Yinzhou Bank, who declined to be named citing company policy. “With the relaxation in reserve requirements, we can lend more in these areas.”

Yinzhou Bank was one of six rural cooperative banks in Zhejiang province that had its reserve-requirement ratio lowered to 16 percent from 16.5 percent, the 21st Century Business Herald reported yesterday, citing unidentified people.

Cheaper Loans

“We are still in a tight liquidity market,” said Qin Liang, vice president at Ningbo Henghou Industrial Group, a company whose main operations are manufacturing steel plates and property investment. “Although I’ve seen borrowing costs from banks fall since last month, the outlook is still uncertain.”

China’s seven-day repo rate, a gauge of the availability of cash in the financial system, sell seven basis points, or 0.07 percentage point, to 4.02 percent, based on a daily fixing by the National Interbank Funding Center. It was 9.11 percent on June 23, the highest level since 2007, after the last increase in lenders’ reserve-requirement ratios.

The monetary authority added a net 22 billion yuan ($3.5 billion) of capital into the financial system this week, after draining 2 billion yuan last week, according to data compiled by Bloomberg. Financial institutions’ yuan positions, accumulated from central bank purchases of their foreign exchange, fell 24.9 billion yuan in October, a central bank report showed this week. The measure is an indication of capital flows.

Lending Jump

“As foreign capital inflows decline and redemptions of maturing bills shrink, the central bank will have to lower reserve ratios on a larger scale by the end of this year,” 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. “Otherwise, financial institutions would have a very difficult time before the year-end and the Lunar New Year.”

Lending typically jumps at the start of each year and demand for funds surges before the weeklong Lunar New Year holiday, which commences Jan. 23 in 2012. New loans exceeded 1 trillion yuan in January this year and last, the only months since the start of 2010 that the threshold was breached. The monthly average was 646 billion yuan during the period, official figures show.

“Cash supply will be very, very tight in the banking system in the coming two months,” said Hu Hangyu, a bond analyst at Citic Securities, the nation’s second-biggest brokerage by revenue. “The credit squeeze at smaller companies makes a reserve-ratio cut quite necessary.”

China’s two-year swap rate fell four basis points today to 2.87 percent in Shanghai, contributing to this month’s 67 basis point slide, according to data compiled by Bloomberg.

“The market is pricing for a cut,” said Wee-Khoon Chong, a fixed-income strategist at Societe Generale in Hong Kong. “Sentiment is shifting fast with hard landing concerns back to the forefront once again. Positions are very one way, where everybody wants to receive and no one wants to pay as rates keep falling.”

To contact the reporters on this story: Kyoungwha Kim in Singapore at kkim19@bloomberg.net; Stephanie Tong in Hong Kong at stong17@bloomberg.net

To contact the editors responsible for this story: Sandy Hendry at shendry@bloomberg.net; Chitra Somayaji at csomayaji@bloomberg.net

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