Bloomberg News

Swaps Show Chance of Cut as UBS Sees Rate on Hold: China Credit

November 07, 2011

Nov. 8 (Bloomberg) -- China’s swap market is starting to indicate chances for an interest-rate reduction in the coming year because of cooling inflation, even as most economists rule out a cut.

The cost of fixing borrowing costs for a year fell below the 3.5 percent benchmark savings rate last month and reached 3.23 percent yesterday, the first time the gap has exceeded a quarter of a percentage point since Aug. 25, 2010. Five of 13 banks in a Bloomberg News survey, including UBS AG, forecast no change in the one-year deposit rate before the end of 2012 and five see increases. CCB International Securities Ltd., Mirae Asset Securities (HK) Ltd. and Guotai Junan Securities Co. see a cut.

Cooling global demand and a slowdown in consumer-price gains prompted the swap rate to drop in the past three months by the most among the largest developing nations excluding Brazil, which cut borrowing costs in August. China’s inflation slowed to 5.5 percent in October and export growth was the weakest in almost two years excluding seasonal distortions, according to Bloomberg News surveys ahead of data tomorrow.

“With growth momentum slowing visibly in the coming months and inflation quickly dissipating, we expect policy to be loosened in early 2012,” said Wang Tao at UBS in Hong Kong. At the same, the scope for rate cuts is limited because deposit rates are already lagging behind inflation, she said.

Wang is among analysts who say the government may loosen lending quotas for banks, cut reserve requirements and add fiscal stimulus rather than lower benchmark rates.

Credit ‘Bubble’

Officials will be cautious in the scale of easing because of the “lesson of the 2008-09 credit bubble,” said Yao Wei, a Hong Kong-based analyst for Societe Generale AG. The government is still dealing with the fallout, including bad-loan risks for banks and a credit-fueled property boom.

Falling costs for commodities such as iron ore and an improved supply of pork have helped to restrain price gains even as the government remains set to miss its full-year target of 4 percent inflation. World food prices dropped the most in 19 months in October, according to the United Nations Food and Agriculture Organization.

China’s inflation is the least of the so-called BRIC nations and compares with 9.7 percent in India, 7.3 percent in Brazil and 7.2 percent in Russia. The Chinese one-year swap rate, the fixed price to receive the seven-day repurchase rate, dropped 0.52 percentage point in the past three months to close at 3.24 percent. The similar rate for Brazil fell 2.22 in that period to 10.27 percent, that for Russia gained 2.09 to 7.07 percent and for India it climbed 0.05 to 8.24 percent.

The yield on China’s 3.93 percent government bond due August 2021 rose two basis points to 3.74 percent yesterday. It has dropped 31 basis points in the past three months.

On Guard

“Inflation is no longer the major concern,” said Liu Li- Gang, an economist at Australia & New Zealand Banking Group Ltd. in Hong Kong who has previously worked for the World Bank and the Asian Development Bank. “The government needs to guard against the risk of a sharp downturn in the first half of 2012.”

Liu sees a cut in reserve requirements for banks as early as this month and a rate increase next year.

New loans may have rebounded to 500 billion yuan ($79 billion) in October from 470 billion yuan in September, according to the median forecast in a Bloomberg survey. UBS sees a monthly average of 500 billion yuan to 550 billion yuan in lending for the final quarter. There is no fixed date for the central bank to release the data.

China has kept interest rates on hold since July in the longest pause since increases began in mid-October last year. The economy grew 9.1 percent in the third quarter from a year earlier, down from 9.5 percent in the previous three months.

Conflicting Forecasts

Nomura Holdings Inc. and Daiwa Capital Markets forecast deposit rates will increase to 4 percent by the end of next year. CCB International, a unit of China Construction Bank Corp, the world’s second-biggest bank by market value, predicts that the benchmark will fall to 2.75 percent by Sept. 30, 2012.

The rate was 4.14 percent in 2008 before emergency cuts to counter the effects of the global financial crisis.

Exports may have climbed 16.1 percent last month from a year earlier, down from 17.1 percent in September, according to a Bloomberg News survey. Growth in shipments to the European Union moderated to 10 percent in September, the slowest pace since 2009 excluding seasonal distortions.

“The European Union is still the largest trading partner for China, and its outlook is very uncertain as the crisis may deteriorate,” said Joy Yang, Hong Kong-based economist at Mirae, South Korea’s biggest money manager. “In the fourth quarter and first quarter, you will see more collapses in China’s exports to Europe and U.S.”

Bond Yields

The yuan dropped 0.19 percent to close at 6.3510 per dollar in Shanghai yesterday, according to the China Foreign Exchange Trade System. That was the biggest decline since Oct. 13.

The cost of insuring Chinese sovereign bonds against non- payment using five-year credit-default swaps was little changed yesterday at about 134 basis points in New York yesterday, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Company bankruptcies and suicides in the eastern city of Wenzhou have focused attention on small businesses’ complaints of a credit squeeze. The People’s Bank of China injected a net 96 billion yuan ($15 billion) of funds into the financial system last week, following two weeks of withdrawals, according to data compiled by Bloomberg.

While China’s economy is cooling, manufacturing is continuing to expand, according to a government-backed index released on Nov. 1.

“There’s no urgency for a rate cut,” Ken Peng, senior economist for China at BNP Paribas SA, said in an interview last week. “Shifting to a loose monetary policy needs a consensus among government officials, which will only be reached when economic growth weakens more obviously.”

--Sophie Leung, Li Yanping, Zheng Lifei. Editor: Paul Panckhurst, Sandy Hendry

To contact the reporter on this story: Sophie Leung in Hong Kong at

To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at

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