A Higher Ground for China Rates; Chinese Government-Bond Yields Are Rising, a Sign of More to Come as Beijing Revamps the Financial System
November 28, 2013 Leave a comment
A Higher Ground for China Rates
Chinese Government-Bond Yields Are Rising, a Sign of More to Come as Beijing Revamps the Financial System
AARON BACK
Nov. 27, 2013 9:38 p.m. ET
Consider it China’s dress rehearsal for financial reform. Yields on Chinese 10-year government bonds rose to over 4.7% last week, their highest level since 2004. Rates have since come down a bit, but they remain high, more than a percentage point above where they were in the first half of the year, despite little change in the growth outlook.Something else is going on. Investors are preparing for higher and more volatile borrowing costs in a preview of what the financial system could look like if the Chinese government follows through with promises to lift controls on interest rates and capital flows.
The immediate cause of the rate rise is tighter liquidity in the interbank market. This in turn is due to a firmer stance by the central bank, which has been emboldened by President Xi Jinping‘s push to reform the economy and wean the system off cheap credit. And there are worries that regulators will soon clamp down on certain types of interbank borrowing.
The interbank crunch has led financial institutions to sell government bonds to raise cash, says ANZ economist Liu Ligang. What’s more, banks were borrowing in the short-term interbank market and using the money to buy government bonds, he says, a profitable carry trade that is now unwinding as funding costs go up.
There are also longer-term reasons that rates could be rising. After this month’s Communist Party plenum, many see Beijing moving closer to scrapping state control of deposit rates, which hold down financing costs across the system. When this happens, borrowers, including the central government, will face higher and less predictable costs. If Beijing allows people to send savings abroad, the impact will be even stronger.
Also pressuring rates are expectations for higher government deficits. The Communist Party’s recently unveiled reform plans call on the central government to take up various new responsibilities, including shouldering more of the fiscal burden borne by local governments, and building out the country’s rudimentary social safety net.
As China moves to a market-driven financial system, interest rates will trend higher. That isn’t ultimately a bad thing—it will lead to a more efficient allocation of capital and help break the addiction to debt-fueled investment. But the transition will be painful.
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