China's Financial Repression Returns Amid Rebalancing Threat

  • Low returns may prompt people to sock more money into savings
  • The hope is liberalized deposits support real returns

China’s savers now effectively pay to keep money in the bank, a hit that undermines the Communist leadership’s campaign to strengthen the role of consumer spending.

Households, whose saving options have been restricted by a roller-coaster stock market and limited mutual-fund industry, now pay 0.1 percent for one-year bank deposits, after adjusting for inflation. That real return has collapsed from 1.95 percent in January.

Low returns mean workers must put away more to meet savings goals, and spend less. That contrasts with most developed economies, where lowering savings rates usually boosts consumption by reducing the opportunity cost of spending. The paradox of thrift rules for China’s famously frugal citizens, who lack the safety net of health insurance and pensions and tend to sock away even more cash to offset lower returns.

After subsidizing banks and industry for decades, China’s savers have for most of the past three years enjoyed positive real returns on their $21 trillion in savings. The slide toward a new phase of financial repression -- when artificially low returns are forced on savers to provide cheap loans for investment or to help banks pay off bad loans -- looms large.

"There’s no such thing as a banking work-out that’s free -- someone has to pay," said George Magnus, a London-based senior independent economic adviser to UBS Group AG. "Typically, Chinese households have paid via financial repression. This time round, it’ll be harder. There’s a sporting chance the rate will prove stickier on the downside. That said, I’d expect little financial relief for the household sector."

The hope is that liberalized deposit rates -- a move taken last month along with the latest rate reduction -- will help preserve real returns for savers as banks compete for deposits.

Low returns on savings and the cheap loans that result are among causes behind China’s reliance on investment for growth. Financial repression, a concept detailed in the 1970s by Stanford University economists Ronald McKinnon and Edward Shaw, also helped fuel an expansion in China’s debt to levels evoking comparisons with the excesses that generated Japan’s lost decade and the Asian financial crisis. China’s total outstanding borrowing has surged by two-thirds since 2008 to 208 percent of gross domestic product.

The positive real returns for savers in the past few years prompted hopes China was starting a new chapter. The outlook was fortified by the central bank, which has on several occasions cut lending rates by more than deposits in a bid to preserve returns for savers. While it last month scrapped a cap on what banks could offer savers, policy makers have signaled they don’t want overly aggressive competition for deposits.

This year marked the start of "the great state refinancing in China," when policy makers made it clear their first priorities include bailing out local governments and helping state enterprises roll over and restructure debts, said New York-based William Hess, co-head of research at advisory firm PRC Macro Ltd. Hess sees China entering a period of low interest rates that will prompt China’s wealthier urban middle class to look beyond the nation’s borders for better returns on their savings.

That could complicate matters for the central bank, as more cash heads for the exit. Capital outflows climbed to $194.3 billion in September, exceeding the previous high of $141.7 billion in August, according to a Bloomberg estimate that also takes into account decisions by exporters and direct investment recipients to hold funds in dollars.

"Policy measures to reduce financing costs for government affiliated borrowers who are crowding out private sector peers means that households are earning lower yields than they probably should," said Hess. "This amounts to a subsidy."

The relatively high spread of 2.85 percentage points between the one-year deposit and lending rates suggests savers are being penalized in favor of banks rather than borrowers, said Michael Pettis, professor of finance at the Guanghua School of Management at Peking University in Beijing.

"This might actually be a neutral proposition for households because the excess profits earned by the banks will reduce the amount by which they will have to be bailed out," he said. "And it is usually households who end up footing the bill -- as they did last time."

Savers do have more options these days thanks to the rise of higher-yielding wealth management products that are sold by banks. These had assets of about 15 trillion yuan ($2.37 trillion) at the end of last year, about 70 percent invested in fixed-income and bank deposits, according to China Banking Wealth Management Registration System data.

"It’s going to be increasingly hard for China to resort to the old playbook of using its commercial banks as fiscal cookie jars while sending the bill to depositors," said David Loevinger, a former China specialist at the U.S. Treasury, now an analyst at fund manager TCW Group Inc. in Los Angeles.

Meanwhile, a rally in stocks has helped restore some wealth. The Shanghai Composite Index gained 6.1 percent this week and has rallied 23 percent from the August low.

Still, returns are falling even on money market funds such as Yu’E Bao, pioneered by Alibaba Group Holding Ltd’s online payment affiliate Alipay. Its annualized yield was 2.9 percent on Nov. 3, compared to a peak of more than 6.7 percent in January last year. It had accumulated almost 604 billion yuan in assets at the end of June.

Total bank deposits at 133.7 trillion yuan dwarf alternative savings vehicles and lifting the deposit rate cap, while a step in the right direction, is more symbolic than substantive because regulators can still pressure banks to stay within allowed limits, said Chen Zhiwu, a finance professor at Yale University in New Haven, Connecticut, and a former adviser to China’s cabinet.

"There is no question that the Chinese savers and consumers will be the ones to bail out the banks and other financial institutions as well as the state-owned enterprises and local governments," he said. "Negative real returns for savers is and will be the new-normal for China."

— With assistance by Kevin Hamlin

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