Chinese Interest Rate Liberalization Is A ‘Major Reason’ SocGen Cut Its China GDP Forecasts For The Next 4 Years


Societe Generale’s Wei Yao has lowered her China GDP forecast to 7.4% in 2013, down from 7.6%. But this isn’t the only downgrade.

The economist has lowered her GDP forecasts through 2016, and now looks for GDP of 6.9% in 2014 (pr. 7.2%), 6.7% in 2015 (pr 6.9%) and 6.7% in 2016 (pr.6.9%).

The downgrade to the 2013 forecast is driven by disappointing economic data and the severe liquidity crunch we saw in June.

Policymakers set forth creative destruction

While interbank rates have come off their highs, other markets are still seeing some pain. For instance, discount rates on bankers’ acceptance bills which show short-term liquidity conditions for corporates, are still 160 basis points higher than May levels.

Going forward she expects credit growth to slow to 16% – 18% year-over-year with ramifications for corporates. It is also expected to cause borrowing costs to rise.

The recent rise in interest rates also showed China’s willingness to stomach short-term pain for long-term gain. In this light she argues that policymakers are likely to allow defaults in bond market and among wealth management products.

This is because it would curb credit growth and “is exactly the creative destruction that China needs to reverse the declining trend in growth efficiency.”

This will also shake the commonly held belief that the state guarantees all interest-bearing securities and cause  investors rest on the belief that financial assets with interest are backed by the state and could cause “capital flight out of some segments of the shadow banking system or the bond market.”

The risks of liberalizing interest rates

The “major reason behind our call for growth deceleration to persist over the next five years,” according to Yao, is the China’s risk-laden path to liberalize interest rates.

Last week, the People’s Bank of China (PBoC) announced that it was removing the floor on lending rates. At the time we pointed out that if policymakers were serious about interest rate liberalization they needed to remove the ceiling on deposit rates and reward Chinese households.

In her new note, Yao points out that removing the ceiling on deposit rates is complicated, could take a few years, and involves some risks to economy.

“If the cap on deposit rates were to be removed now, banks could feel pressure to raise deposit rates to compete for funding, which  may be only partially passed on to borrowers due to the economic slowdown,” she writes. These also include the risk of rising non-performing loans and of the central bank losing control over monetary policy if it doesn’t move carefully. 

But Chinese policymakers’ move to remove the floor on lending rates shows “the new leadership’s intention to fast-track interest rate liberalization.”

And what should investors take away from this? “The implication is that the authorities would also be willing to tolerate and prepare for the potential risk that will likely emerge as the process moves forward.”