China Opts for Financial StimulusDecember 4, 2014
On Friday, Nov. 21, for the first time in more than two years, the Chinese central bank, the People’s Bank of China (PBoC), cut interest rates, giving a welcome boost to global markets. The PBoC had resisted increasing calls for more aggressive easing as the Chinese economy slowed. It did not want to undermine planned structural reforms that would provide a better basis for long-term growth. Surprising markets, the PBoC reduced the one-year lending rate by 40 basis points and the one-year deposit rate by 25 basis points. The central bank is also giving banks more freedom to set their interest rates. While the PBoC said these moves do not mean a change in monetary policy and characterized the current 7.3 percent per annum growth rate as “reasonable,” we suspect that the slowing of the Chinese economy is an increasing concern for China’s leaders and now for the PBoC as well. An important consideration was probably the fact that efforts to increase liquidity, the preferred means of stimulating the economy, have not lowered borrowing costs for smaller companies.
The slowdown in the Chinese economy remains modest. We are projecting growth to remain close to 7 percent in the coming year, but there are significant downside risks from the correction in the real estate sector and its implications for the financial sector, as well as from the struggles of firms suffering from over-indebtedness. China’s total debt-to-GDP ratio exceeds 250 percent. Friday’s move by the PBoC may help limit those risks and may also signal the readiness of policy makers to take other supportive action.
Global markets appear to regard China’s rate cuts as an indication of the government’s determination to keep the Chinese economy growing at close to the current rate. The move will likely be followed by similar actions by the central banks of India and Korea. Global markets were also boosted by comments by Mario Draghi, president of the European Central Bank, who hinted strongly that further easing measures to strengthen economic growth and counter low inflation in the Eurozone could come as early as next month. The iShares MSCI ACWI ex-US ETF, ACWX, which tracks all equity markets outside the US, rose 1.25 percent during the day Friday.
China’s equity market is the third largest in the world (only those of the US and Japan are larger), and it has been struggling this year. On November 20, the MSCI equity market index for China was down 5.6 percent over the past three months and down 1.1 percent for the year to date. On the 21st, however, it rose by 0.5 percent. This index covers investible (to international investors) China equities with the exception of US-listed shares of Chinese companies. It excludes Chinese A shares, that is, securities incorporated in Mainland China that are listed on the Shanghai or Shenzhen stock exchanges and traded in renminbi, the Chinese currency. The A shares make up the largest portion of the Chinese equity market. The China A-shares market was up 9.5 percent year-to-date on November 20, according to the MSCI A Shares index, and rose an additional 1.7 percent on Nov. 21, significantly outperforming the China shares available to international investors.
There has not been the expected interest thus far in the new “China Stock Connect” trading scheme that enables investors in Hong Kong and Shanghai to directly buy shares in each other’s markets. However, as the scheme was launched only this past Monday, it is too early to make any judgments. The program represents an important step in liberalizing the mainland market and increasing international access to A shares. One possible positive result of this linkage could be encouragement to MSCI and FTSE to add Mainland China stocks to their global benchmarks. That step alone would lead to substantially increased inflows to the Chinese market. Looking forward, while significant risks remain, the PBoC’s rate cuts, together with the opening of the China Stock Connect trading scheme, strengthen our conviction to maintain the China positions in our International and Global ETF portfolios.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.
The preceding is an abridged commentary by Cumberland Advisors and has been reposted with permission. Cumberland Advisors commentaries are available at http://www.cumber.com/commentary_archive.aspx.
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