China’s government needed lower borrowing costs to clean up a local debt mess. The central bank obliged.
The three-month Shanghai Interbank Offered Rate has tumbled 200 basis points since March 31, heading for the biggest two-month drop since 2008. That coincides with the government kicking off a municipal bond program and the exchange of regional loans into lower-yielding notes. Jiangsu province and Xinjiang autonomous region both sold three-year debt for less than 3 percent last week, almost matching the sovereign, after the start of issuance was delayed in April.
Central bank Governor Zhou Xiaochuan has accelerated monetary easing just as local authorities kick off more than
1.77 trillion yuan ($286 billion) of bond issuances, a four-fold jump from 2014. Banks are the biggest buyers of government debt and will have more appetite for the securities as loan rates decline. Local-government obligations may have reached 25 trillion yuan, more than the size of Germany’s economy, Mizuho Securities Asia Ltd. estimates.
“The central bank will do everything it can to make sure the municipal bonds are sold at low cost,” said Wang Ming, chief operations officer at Shanghai Yaozhi Asset Management LLP, which oversees 4 billion yuan of fixed-income securities. “If rates rise because of the increased supply, leading to even higher costs than previous borrowings, what would be the point of the debt swap? So rates will be capped.”
Interbank borrowing costs remained stubbornly high even after the People’s Bank of China cut the one-year deposit rate to 2.25 percent from 3 percent since November, and lowered major lenders’ reserve-requirement ratio to 18.5 percent from 20 percent. Three-month Shibor was 4.9 percent until the end of the first quarter, before sliding to 2.9 percent Monday.
Banks cut borrowing costs as it became clear that money-market rates would remain low. The seven-day repurchase rate, which is influenced by PBOC activities, averaged 2.18 percent this month and 2.87 percent in April, down from 4.49 percent in March. The central bank rolled over lending facilities and refrained from carrying out operations to halt the decline.
“The expectation for interbank liquidity to stay loose in the foreseeable future gives banks the incentive to lend out longer funding,” said Becky Liu, a senior rates strategist at Standard Chartered Plc in Hong Kong. “It is much needed under the current environment to ensure local government bond issuance can go smoothly. The rate is likely to fall further.”
The eastern province of Jiangsu kick-started this year’s municipal bond issuances last week, selling three-year notes at
2.94 percent. Xinjiang achieved an even lower cost three days later, issuing similar debt at 2.84 percent, the same as that on Ministry of Finance securities.
The 1.77 trillion yuan sale plan includes 500 billion yuan of general bonds and 100 billion yuan of special notes, according to the 2015 budget. In addition, local governments can roll over 171.4 billion yuan of securities due this year and convert 1 trillion yuan of maturing debt -- which can be in the form of loans and trusts -- into municipal securities.
Demand for municipal bonds was also supported as regulators ruled this month that they can be used as collateral to obtain preferential loans. Local governments have 1.86 trillion yuan of maturing debt this year, as well as a further 919.3 billion yuan in contingent liabilities.
The moves are part of efforts to make local-government debt more transparent after such borrowings contributed to a jump in liabilities. Regional authorities set up thousands of funding units to finance projects from sewage systems to subways after a 1994 budget law barred them from issuing notes directly. That rule was changed last year.
Another reason for falling interbank rates is the slowdown in capital outflows that has left finance companies with ample supplies of yuan. Chinese banks sold a net 106.2 billion yuan of foreign exchange in April, compared with a deficit of 406.2 billion yuan a month earlier, State Administration of Foreign Exchange data show. The yuan rose 0.1 percent last week to
6.1976 a dollar. The Bloomberg Dollar Spot Index, which tracks the greenback versus 10 major peers, declined 3 percent in April, the biggest monthly drop since 2011.
“The capital outflows moderated thanks to a stall in the dollar’s advance,” said Xie Yaxuan, Shenzhen-based chief economist at China Merchants Securities Co. “We expect cross-border flows to continue improving.”
Monetary easing has so far failed to revive an economy growing at the slowest pace since 2009. The preliminary Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics was 49.1 for May, missing the median estimate of 49.3 in a Bloomberg survey. Numbers below 50 indicate contraction.
The PBOC will lower the reserve ratio by another 200 basis points this year, or even more if outflows worsen, economists led by Beijing-based Liang Hong at Goldman Sachs Group Inc. wrote in a May 17 report. The central bank has enough room to clean up local-government debt, with its balance sheet growing 16 percent in two years, compared with 96 percent for the Bank of Japan and 44 percent for the Federal Reserve.
“Tepid growth will continue to be the main reason for us to believe rates will be lower,” said Dong Dezhi, a Shanghai-based fixed-income analyst at Guosen Securities Co.
— With assistance by Helen Sun