China: More broad-based funding cost decrease
In this blog, we explore why Chinese authorities are guiding down household investment return and why this guidance could anchor CGB yields in the medium term.
While policy rates (such as the 7-Day reverse repo or the 1-year Medium-term Lending Facility rate) have stayed at current levels for quite a while, other return rates within the household investment universe (i.e. deposit rates or insurance products’ promised return rates) have been moving down, implying a downward trend of average financial asset investment return. In this blog, we explore the reasoning behind the move and why this move could be a reason for the Chinese Government Bond (CGB) yield to remain anchored.
Why are the authorities keen to provide downward guidance on household investment return? We see the two key reasons:
Provides a buffer to the banking sector for further credit growth. From March 2020 to March 2023, the People’s Bank of China (PBoC) cut policy rates by 50bps and 1-year and 5-year Loan Prime Rates (LPR) also dropped 50bps (which is more on the asset side of the banking sector), while the deposit rate stayed roughly unchanged until late last year (which is on the liability side of the banking sector). Additionally, on the liability side, we noted that ~70% of banking sector’s funding comes from deposits and only ~14% comes from interbank borrowings and bond market, suggesting that the policy rate cut did not help much in reducing the funding cost. Meanwhile, over the past three years, an increasing number of households chose time deposits rather than current deposits for higher interest payments at deteriorating income levels, making banks’ deposit interest payout even higher. During the same period, average Net Interest Margin (NIM) of Chinese commercial banks decreased by 20bps to 1.91% by the end of 2022, compared to 2.1% at the beginning of 2020. The recent move by medium and small banks on lowering the deposit rate—following the actions of large banks in September of last year—should further ease the NIM pressure making banks feel more comfortable boosting up loan growth. Note that Chinese authorities frequently “guide” the banking sector to support “targeted” sectors (like the renewables or tech) and, therefore, it is important to prevent excessive squeeze in bank margins – so that the bank’s lending capabilities are preserved.
Incentivizes households to spend rather than save. According to a PBoC report in November 2019, ~60% of Chinese households’ assets are in housing and ~20% in financial assets. Among financial assets, ~40% are in deposits, ~27% are in WMPs (Wealth Management Product)1 and ~7% are in insurance products. After revoking guaranteed returns on WMPs, lowering the deposit rate, it is reported that, recently authorities are using window guidance and requiring insurance companies to lower their promised return rate when issuing new insurance products. Chinese household savings reached a record high in March 2023 and remain elevated so far this year. Even with strong tourism numbers during China’s Labor Day on May 1st, we note that average spending is still 24% lower than pre-COVID levels, echoing increasing talks from onshore media on consumption downgrade. By making investment returns less attractive, we think authorities are targeting and incentivizing increased household spending (supporting the gradual rotation away from investments towards more consumption-driven growth). Low Producer Price Index (PPI) and Consumer Price Index (CPI) pressures (and closed capital account) allow Chinese authorities to move in that direction without major concerns with foreign exchange (FX) depreciation or inflation reacceleration.
Previously, we highlighted that there is a growth perception gap between China onshore and offshore markets, which may help to explain why CGB yield has been coming down despite the strong Q1 GDP growth. We think authorities’ overall guidance on lowering household investment return is another part of the story. Chinese banks and insurance companies are important bond holders in the onshore CGB market accounting for ~65% of total holdings and they now have more flexibility in asset allocation with lower funding costs. The CGB becomes attractive by adding in some degree of financial leverage. At the same time, China’s capital account continued to be closely managed, suggesting no meaningful overseas alternative investment available. In our view, all this combined is likely to anchor CGB’s yield in the medium term.