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Li Honeymoon Off as Easing Bets End in Shibor Swap: China Credit

The People’s Bank of China has held its benchmark lending rate at 6 percent since cutting to that level in July. Photographer: Nelson Ching/Bloomberg
The People’s Bank of China has held its benchmark lending rate at 6 percent since cutting to that level in July. Photographer: Nelson Ching/Bloomberg

Nov. 7 (Bloomberg) -- Inflation concerns have prompted swap traders to scrap bets Li Keqiang will ease monetary policy after he is flagged as China’s next premier at a Communist Party congress starting tomorrow.

The cost to lock in the three-month Shanghai interbank offered rate for a year rose 25 basis points in the past month to 3.76 percent, four basis points above the benchmark floating rate after trading below it for 18 months. The yield on the June 2013 bonds of China Construction Bank Corp., the nation’s second-biggest lender, climbed 15 basis points last quarter to 3.68 percent. Globally, financial companies pay an average 2.74 percent, according to Bank of America Merrill Lynch indexes.

The pessimism of traders in Shanghai is at odds with global banks including HSBC Holdings Plc, which wrote this month that there is “little doubt” China’s new leaders will gear up stimulus for the world’s second-biggest economy during the transition. Li needs to balance the risks of rising bad loans with inflation forecast to reach 3.4 percent in the third quarter of 2013, up from 1.9 percent in September, according to the median forecast of 28 economists surveyed by Bloomberg News.

“Borrowing costs for companies and between banks may rise because inflation will go up and liquidity won’t be as abundant,” said Rainy Yuan, a Shanghai-based analyst at Masterlink Securities Corp., a brokerage and underwriting company. “There are a lot of uncertainties for policy makers to weigh next year. They don’t want to loosen further to stir up inflation but neither should they tighten too much to hurt the economy.”

Monetary Policy

The People’s Bank of China has held its benchmark lending rate at 6 percent since cutting to that level in July. The central bank has also kept the reserve ratio for the biggest banks at 20 percent since May.

Authorities have been on pause since then as inflation has ticked up from 1.8 percent in July, its lowest since November 2009. The U.S. Federal Reserve’s third round of so-called quantitative easing threatens to lead to further acceleration of price rises, according to Masterlink Securities’ Yuan.

“Inflation pressure will come back again next year as pork prices may rebound and U.S. QE3 threatens to add imported inflation,” she said.

The increase in the inflation rate comes as economists forecast economic growth will pick up this quarter to 7.7 percent from 7.4 percent in the three months ended Sept. 30, the weakest growth since the first quarter of 2009.

Li’s Challenges

Li is currently vice premier and a member of the Politburo Standing Committee, the highest ruling body in the party. He will work with Premier Wen Jiabao in setting monetary policy until a March session of the legislature at which he is expected to formally take over.

China’s third-quarter growth may have been weaker than official data indicate, as reflected in slowing electricity production and other data, according to analysts at Standard Chartered Plc and Capital Economics Ltd. Li was quoted in 2007 as saying he watched data on power, rail cargo and loans because gross domestic product numbers were “man-made.” The remark was published in a leaked diplomatic cable published by WikiLeaks in late 2010.

Chinese commercial banks’ delinquent obligations may rise 10 percent this year and accelerate in 2013 if concerns about a rebound in inflation lead authorities to tighten monetary policy, according to China Orient Asset Management Corp. The company is one of the nation’s four state-owned asset managers established in 1999 to take over trillions of yuan of bad loans from the country’s largest lenders.

Bad Loans

Total non-performing loans at China’s four-biggest banks increased 2.1 billion yuan ($336 million) in the third quarter to 295.7 billion yuan, according to separate statements from the lenders last month.

The yuan rose 0.03 percent to 6.2436 per dollar as of 10:03 a.m. in Shanghai, according to the China Foreign Exchange Trade System.

“A tightening monetary policy is generally negative to credit quality of banks,” Stanley Li, an analyst at Mirae Asset Securities (HK) Ltd., a unit of the South Korean brokerage, said by telephone on Nov. 5. “If the inflation rate rises to more than 5 percent, there’s likely to be an obvious tightening and this will be negative to credit quality.”

As investors bet that interest rates are set to track inflation higher next year, lenders’ borrowing costs have risen. The yield premium on top-rated five-year corporate bonds over similar-maturity government debt climbed to a more than five-month high at 164 basis points on Nov. 5.

The yield on the benchmark 10-year government note fell one basis point to 3.58 percent yesterday, according to Chinabond.

Rate Forecasts

The central bank will likely hike rates twice next year, lifting them 100 basis points higher in total, according to Sun Mingchun, a Hong Kong-based economist at Daiwa Capital Markets Hong Kong Ltd., a unit of Japan’s second-largest brokerage.

Rate increases of that size “shouldn’t affect bad loans significantly,” Sun wrote in an e-mailed response to questions on Nov. 6. “Chinese leaders should pay more attention to the long-term sustainable growth and the underlying structural reasons for the bad loans, rather than focusing on low interest costs.”

Five-year credit-default swaps insuring sovereign notes against non-payment fell three basis points to the lowest level this year at 62 basis points yesterday, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities if an issuer fails to adhere to its debt agreements.

Profits Slow

Chinese banks may post slower profit growth in the fourth quarter as their lending margins narrow and provisions for bad debt rise, according to Sanford C. Bernstein & Co. Pretax profit in the three months ending in December may grow by 9 percent, down from 12 percent in the third quarter, analysts including Mike Werner at the research firm wrote on Nov. 5. Bad loan formation is likely to accelerate this quarter, according to the report.

Central-bank moves to grant more flexibility in setting interest rates have led banks to pay a premium of as much as 10 percent over the benchmark deposit rate, threatening their margins. The weaker growth in the world’s second-largest economy has also pushed up non-performing loans.

“The figure is bound to rise in the fourth quarter and may further increase next year as monetary policy gets tighter,” Masterlink Securities’s Yuan said.

To contact Bloomberg News staff for this story: Stephanie Tong in Hong Kong at; Jun Luo in Shanghai at

To contact the editor responsible for this story: Shelley Smith at

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