No More Room for Cuts to China’s Benchmark Rate as Net Interest Margins Plunge

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Domestic analysts speculate that China is unlikely to cut interest rates in future, after the benchmark rate held steady for an eighth consecutive month in April following strong economic and credit growth in the first quarter of 2023. Net interest margins have also dropped to their lowest levels on record, leaving little rom for depository lenders to further reduce loan rates.

LPRs hold steady in April

On 20 April, the National Interbank Funding Center announced the Loan Prime Rates (LPR) for April were 3.65% the one-year tenor and 4.3% for tenors of five years or more. The LPR has remained unchanged for eight consecutive months since August.

The loan prime rate (LPR) (贷款市场报价利率) in China is the lending rate provided by commercial banks to their highest quality customers, and serves as the benchmark for rates on other loans.

At present the LPR reporting group is comprised of 18 commercial banks in China, including an original core group of 10 national banks, plus two municipal commercial banks, two rural village commercial banks, two foreign invested banks and two privately operated banks.

Wen Bin, chief economist with China Minsheng Bank, says a range of factors contributed to the stationary position of both LPR’s in April.

These include the rate for medium-term lending facilities (MLF) – one of Chinese central bank’s chief open market instruments – remaining unchanged, alongside a recovery in the broader economy and demand for credit since the start of the year.

“Following the launch of LPR reforms, the MLF rate serves as the anchor rate for LPR quotes, and any changes will have a direct impact on the LPR,” Wen wrote in a recent opinion piece.

On 17 April the Chinese central bank undertook 170 billion yuan in MLF operations at an unchanged bid rate of 75%, achieving a net injection of 20 billion yuan.

Cuts to interest rates implemented in 2022 at the behest of regulators are also putting pressure on the net interest margins of banks, leaving less space for reductions to LPR quotes.

“In addition to policy rates such as MLF, the impact of bank costs and demand for loans on the spread rate are also taken a consideration,” Wen wrote.

Prior to the MLF operations in April, many small and medium-sized banks in Guangdong, Henan, Hubei and other province had already announced a reduction in deposit rates, which triggered speculation of a new round of interest rate cuts and a further reduction in LPR quotes.

Wen argues, however, that the recent reduction in deposit rates by some small and medium-sized banks should be viewed as a continuation of the downward adjustment of listed rates by lenders as part of China’s interest rate self-discipline mechanism, and does not herald the start of a new round of cuts to deposit rates.

Chinese economy and credit demand both see strong start to 2023

A strong start to 2023 for the Chinese economy as well as robust growth in credit demand has dampened the need for further cuts to rates.

“From a macro-data perspective, the domestic economy has steadily recovered in the first quarter, and the real estate market has shown a stabilizing and warming trend, reducing the need for further loosening policies,” Wen writes.

Official Chinese data indicates that the GDP growth rate in the first quarter was 4.5% in year-on-year (YoY) terms, with a quarter-on-quarter (QoQ) growth rate of 2.2%.

Consumption has displayed a steadily improving performance since the start of the year, partially due to base effects and endogenous trend recovery. Total retail sales of consumer goods in March increased by 10.6% compared to the same period last year, for a significant improvement compared to the 3.5% growth posted in January-February.

Manufacturing investment and infrastructure investment have maintained high year-on-year growth rates since the start of 2023. Fixed asset investment in the first quarter grew 5.1%, edging down 0.4 percentage points compared to the January-February period yet still higher than the 4.5% GDP growth rate, demonstrative of its key role in driving the Chinese economy.

Real estate development investment fell by 5.8% YoY in the first quarter however, slightly lower than the -5.7% decline in January-February. However, real estate sales in March increased by 6.3% year-on-year, well ahead of the -0.1% decline in January-February. Housing prices have risen slightly, while a rebound trend in home prices in 70 major cities across China has continued.

China’s import and export data came in well ahead expectations. The overall YoY growth rate in the first quarter was 4.8%, for an increase of 2.6 percentage points compared to the fourth quarter of last year.

Credit showed a strong expansionary momentum in the first quarter, with supply and demand both strong, and the new credit and total social financing both greatly exceeding expectations.

Wen highlighted the role of the the current low interest rate environment in spurring demand for credit. In the first quarter, RMB loans increased by 10.6 trillion yuan, for an expansion of 2.27 trillion yuan compared to the same period last year, while total social financing was 14.53 trillion yuan, for a 2.47 trillion yuan YoY increase.

Chinese central bank adopts moderate tone

The strong start to 2023 for China’s economic and credit growth mean that further rate cuts are unlikely, with recent statements from the Chinese central bank signalling a position of restraint.

In terms of policy tone, the recent monetary policy meeting minutes released by the central bank for the first quarter deleted the expressions ‘triple pressure’ and ‘countercyclical adjustment,’ while also indicating that ‘the domestic economy is showing a trend of recovery and improvement.

“The assessment of the domestic economic situation is more optimistic,” Wen writes. “It is expected that subsequent monetary easing operations will be more cautious, structural policy tools will play a greater role, and policy demands will shift from the previous continuation of ‘strengthening’ towards ‘stabilisation.’

“Consequently, given the current context of steady economic recovery, significant increases in credit and total social financing data, and a moderately adjusted policy tone, there is no strong need or urgency for further reductions to interest rates.”

Net interest margins fall to record lows

Wen further points out that because the net interest margin of banks have dropped to perilous lows, there may be no more downward room for LPR quotes and lending rates are likely to remain stable.

“Since last year, loan rates have significantly decreased, and new loan pricing has clearly deviated from the LPR, with some deposit and loan rates showing structural inversion,” Wen writes.

“In December 2022, the interest rates for new loans, general loans (excluding bills and mortgages), corporate loans, bills, and mortgages all fell significantly in year-on-year terms, with decreases of 62bp, 62bp, 60bp, 58bp, and 137bp, respectively.

“Corporate loan rates fell below 4% for the first time, and personal housing loan rates saw a rare decrease of over 100 basis points.”

The rapid decline in loan interest rates, combined with relatively inelastic deposit costs on the liability side, has caused the net interest margin of commercial banks to fall to its lowest level on record.

“The impact of the pandemic, redemptions of wealth management products, and economic uncertainty have led to an increase in household savings and a decrease in corporate investment,” Wen writes.

“The comprehensive cost of funding for listed state-owned banks rose by 3 basis points to 2.33% in 2022 compared to 2021, with deposit costs rising by 9 basis points to 1.78%.

“Under pricing pressure on both the assets and liabilities sides, the net interest margin of commercial banks fell further to a historic low of 1.91% in 2022. State-owned banks, joint-stock banks, municipal commercial banks, and rural commercial banks have net interest margins of 1.90%, 1.99%, 1.67%, and 2.10%, respectively.”