An easing of monetary policy is underway in China

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On the last day of February, the People’s Bank of China (PBoC) announced a cut in benchmark lending rates by 25bp to 5.35% with benchmark deposit rates being reduced by 25bp to 2.50%. This is the second rate cut in three months and bolsters our conviction that further broad-based monetary policy easing is on the way this year. Chinese equities will, in our view, get a boost from looser monetary policy.

 

Easing on the way

After the initial rate cut in November 2014 and the cut in the reserve requirement ratio (RRR) for banks in early February 2015, the latest rate cut was largely in line with consensus expectations,  shaped in turn by recent weak economic data and growing signs of deflation. These monetary policy measures are aimed at lowering general financing costs, propping up the real economy and stabilising growth in China.

China’s benchmark interest rates

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Source: Bloomberg, March 2015

This latest rate cut reinforces our view that a cycle of monetary easing is underway in China and that the authorities are willing to use interest rates and the RRR as tools to support growth.

We expect further monetary easing this year. Borrowing costs are still relatively high and the economy remains weak. February’s Purchasing Manager’s Index (PMI) was 49.9, signalling a contracting eocnomy for the second month in a row. After the first rate cut, the average lending rate fell from 6.97% (in September) to 6.77% (in December 2014). However, the real borrowing cost is not low enough to offset persistent PPI deflation (-4.3% YoY in January) and low CPI inflation (0.8% YoY in January). To substantially reduce real borrowing costs, we expect further rate cuts and more liquidity to be injected into the market. (Source of all data: Bloomberg, March 2015)

More potential upside for equities

We expect the latest rate cut to help reduce borrowing costs and benefit capital sensitive sectors such as property. In addition, it is likely, in our opinion, to increase the appetite among investors for Chinese equities and increase investments in the stock market over the short to medium term. Therefore, we expect the A-share market, as represented by the CSI 300 index, to rise substantially in the medium term as more investors enter the market, especially when real borrowing costs are lowered further.

CSI 300 index and a-shares daily turnover

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Source: Bloomberg, March 2015
Emmanuelle Wilbrod

Investment Specialist – BNP Paribas Investment Partners Asia Ltd

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