Lowering the Financing Cost for the Real Economy
In 2014, a large amount of companies have to pay back their debts. Lowering the financing cost for the real economy and hedging the deleverage risks has become an urgent task for China. The central bank's cut on the reserve requirement ratio for county-level rural commercial lenders comes at the right time on the back of rising borrowing costs.
[Editor's Note: The reserve requirement ratio sets the minimum fraction of customer deposits that each commercial bank must hold as reserves rather than lending, and is an important monetary tool used by central banks. Lowering the ratio is often aimed at boosting bank lending.]
The debt ratio—total liability against total assets—in China's non-financial sectors has surpassed 90 percent, an internationally recognized alarm level. As of the end of 2013, China's non-financial companies had a total liability of $12 trillion, 120 percent of the GDP. By the end of 2014, this number will accumulate to $13.8 trillion, surpassing that of the United States, according to global rating agency Standard & Poor's.
A total of 1,706 corporate bonds require interest payment or redemption in cash in 2014, an overall amount of 277 billion yuan ($44.4 billion). The required interest payment is more than 10 billion yuan ($1.6 billion) each month on average in 2014. The amount is even forecast to surpass 20 billion yuan ($3.2 billion) in October, November and December, signaling default risks, according to data from financial information service provider Dazhihui Aastocks.
A rise in leverage ratio in China's non-financial sectors is partly caused by the massive stimulus package adopted after the 2008 financial crisis. The drastic credit expansion from 2003 to 2007 didn't lead to overleverage while since 2008, the leverage ratio has become too high after the credit expansion because the labor productivity of the manufacturing sector had declined.
Another reason for a rise in debt ratio is that financing costs are higher than the return on investment in China. Right now, the borrowing cost of Chinese companies is two times that in developed countries. For instance, the loan interest rate for Chinese firms was 6.15 percent in 2013, much higher than the 2.25 percent in the United States, 1 percent in Japan and 3.5 percent in Germany.
After the Spring Festival holiday (January 31-February 6), commercial banks raised their lending rates by 60 percent or even higher. The gap between financing cost and corporate profitability was further widened. Against the backdrop of a slowing economy and declining profits, some companies' profits can hardly cover the interest expense. Defaults are thus likely to occur.
Therefore, lowering financing costs is extremely important. China's quantitative control is giving way to price control. Judging whether the monetary policy is loose or tight should be dependent on interest rate changes. If interest rate goes down, the monetary policy should be viewed as too loose, regardless of the condition of open market operations. If the rate surges, the policy should be viewed as too tight.
China's interest rate policies will be affected by future adjustment of monetary policies by the U.S. Federal Reserve. The Fed will increase interest rate three times from now to the end of 2015. Monetary tightening by the Fed will deal the heaviest blow to the Chinese economy in 2015 and 2016.
In order to reduce the debt risks of non-financial companies, a market-based capital supplement mechanism should be established to restore their debt ratio to a healthy level. Companies' capital should be complemented by market-based financial instruments, such as profit reserves, equity financing, private equity and stock right transfer. Competitive investment of local governments should be reined in and the vigor of private capital should be unlocked, so that social resources can be allocated more effectively.
In addition, in order to maintain stable interest rates, there should be a "buffer zone" for any monetary policy changes. For instance, the central bank can use the excessive reserves kept by commercial banks or financial institutions to influence interest rate and overall liquidity. After the credit crunch in June 2013, the reserve requirement ratio of financial institutions was hiked to 2.1 percent and the excessive reserves totaled about 2 trillion yuan ($320 billion). When necessary, the central bank should redistribute the money stock to increase the efficiency of monetary policy.
This is an edited excerpt of an article by Zhang Monan, an associate research fellow at the China Center for International Economic Exchanges, published in Economic Information Daily
2.6 tln yuan
China's tax revenue in the first quarter, up 9.9 percent year on year
220.3 bln yuan
Value-added tax exemption as of the end of March
7.76 tln yuan
Outstanding loans on land mortgage in 84 major cities as of the end of 2013
310.7 bln yuan
The profits of centrally administered state-owned enterprises in the first quarter, an increase of 3.4 percent year on year
Year-on-year growth of insurance premium in the first quarter
Average profit margin of top 100 restaurant chains in 2013, a decline of 3.62 percentage points from 2012