LPR move works, but stable realty calls for more
After the People's Bank of China, the central bank, cut the one-year medium-term lending facility interest rate by 10 basis points to 2.75 percent on Aug 15, follow-up loan prime rate cuts took place as scheduled on Aug 22, with the one-year LPR dropping by 5 bps to 3.65 percent, and the five-year or longer LPR 15 bps lower at 4.3 percent.
This is the second asymmetric downgrade eyeing the five-year LPR. The first was in May, when neither the MLF nor the one-year LPR was changed while the five-year LPR was adjusted with a single maximum-sized move of 15 bps. As a follow-up measure, the move in August was seen as an ongoing signal of stabilizing the property sector and facilitating long-term investment. After the latest round of asymmetrical rate cuts, the one-year and five-year LPR rates have basically converged since the sector's reform in September 2018.
Behind the cuts
The recent move is seen as a key measure to combat turmoil in the housing market.
First, the LPR cut broadened room for more mortgage interest rate cuts, allowing homebuyers to save money, which will ultimately boost tepid homebuying demand. Since the fourth quarter, mortgage rates for first and second home purchases in designated cities fell by 139 bps and 93 bps to 4.35 percent and 5.07 percent, respectively. Since the beginning of this year, the national weighted average interest rate for home loans has dropped by 101 bps to 4.65 percent, while the five-year LPR has only declined by 35 bps over the same period. The latest round of MLF reductions, together with the five-year LPR cut, has created more space for reductions in mortgage interest rates.
Based on calculations cited by listed lenders, and mainly considering medium- and long-term loan balances recorded by financial institutions, we estimate that the asymmetrical reduction of the LPR is expected to save 214.1 billion yuan ($31 billion) in interest expenses, or some 0.2 percent of the nation's GDP. From the perspective of housing loans, considering that the balance of personal housing loans at the end of the second quarter was 38.9 trillion yuan, the 15 bps reduction in the five-year LPR is equivalent to an annualized reduction of 58.3 billion yuan in residential mortgage interest. The mortgage interest rate has already dropped by 101 bps in the first half, and the downward move in annualized mortgage interest will have saved more than 450 billion yuan for homebuyers.
Second, as for MLF, after the rate cuts, interest rates of bank bonds may also see declines. Since mid-July, the interest rates of one-year negotiable certificates of deposit, or NCDs, have dropped by nearly 40 bps. In the past year, there has been 4.95 trillion yuan in MLF, 21.4 trillion yuan in NCD and 7.1 trillion yuan in bank bonds. Therefore, we estimate that the recent interest rate cut may save about 33-93 billion yuan in annualized costs for banks. Bank interest margins may narrow and measures such as the reform of bank debt-side deposit interest rates may continue to deepen in the future.
As we see things, the asymmetrical downgrade of the LPR involves a balance between multiple policy objectives. We believe that the five-year LPR reduction reflects regulatory efforts to boost residential housing demand and ease the trend of deleveraging in the sector. With lower-than-expected reductions in the one-year LPR, and it also being the first time in history that the decline is lower than MLF, we think it may be because corporate loan interest rates have been greatly reduced amid the backdrop of weak credit demand this year. In fact, the corporate loan interest rate was only 4.16 percent in June, which should be reduced by 42 bps within this year. Taking into account structural inflation and exchange rate pressure, it is indeed not that necessary to reduce the benchmark interest rate.
Third, the move is also expected to slow down the trend of prepaying loans. The net increase in residential mortgage loans in the first half was only 540 billion yuan, a decrease of 75 percent from 2.2 trillion yuan in the first half of last year, while the real estate transaction area in the first half only decreased by 34 percent year-on-year, which may be due to the increasing loan prepayment borrowers.
We think the reasons may lie in the fluctuation of financial products such as public funds and wealth management products this year, whose expected investment yield has not met investor expectations, while stock mortgage interest rates of home purchases between 2017 and 2021 were generally at a high level of more than 5 percent. Since the rate can be lowered simultaneously with the LPR, reducing debt costs for borrowers will help slow down the trend of prepaying loans and stabilize the bank's credit stock.
Last but not least, one cannot rule out a deposit rate cut by the same amount. The first-quarter monetary policy report mentioned that the PBOC would establish a market-based adjustment mechanism for deposit interest rates in April, and adjust the deposit interest rate level with reference to the 10-year treasury bond yield and the one-year LPR. The second-quarter monetary policy report also emphasized the key role of the market-based adjustment mechanism of deposit interest rates, and efforts to stabilize the cost of bank liabilities. The 10-year treasury bond yield has fallen since April. If the one-year LPR is cut further, the fixed deposit rate may also drop simultaneously, which we expect to play a positive role in stabilizing debt costs.
More support still needed
Amid the turmoil in housing deliveries and sporadic COVID-19 resurgences, the nation's economic performance in July was still weaker than expected. An economic gauge commissioned by China International Capital Corp remained stagnant at around 90 percent, indicating less vitality in economic activity. Property market sales remain weak. In the first 20 days of August, property sales area in 30 key cities remained at low levels. To this end, the policy of stabilizing demand should be furthered to continue support for the overall economy.
In addition, continued policy efforts are beneficial to the recovery of bank valuations, which in turn will help keep credit and financial systems on a steady track. Currently, valuations of many banking stocks are at or near historic nadirs. And related share prices have fallen recently, mainly due to concerns over the quality of property-related loan assets. With the recent interest rate cut reflecting enhanced policy support, and policy banks' special loans to "guarantee home deliveries", we can see the concerns over asset quality are gradually easing. The narrowing of the M1-M2 gap also indicates that funds are entering the real economy. There are good things happening, but more policy support is still needed to further the trend, which helps ease pessimism over banking stocks for now. And as the effect of the policy gradually becomes apparent, valuations of banking stocks will also recover.
In terms of monetary policy, we expect that short-term liquidity will remain loose. With relatively weak growth expectations and loose monetary policy, there is still room for long-term interest rate reductions. In the future, the strength of the currency should be determined based on growth momentum, and should also be strong enough to tolerate a certain degree of structural inflationary pressure.
Fiscal efforts should also be enhanced. As real estate infrastructure is constrained by debt, fiscal policies should give more focus to consumption and be facilitated to shore up the demand side more efficiently. In terms of real estate, asymmetrical interest rate cuts indeed have given signals of stabilizing the property market, but interest savings may still not be enough to stabilize overall confidence. Bailing out property as quickly as possible, eliminating debt burdens, ensuring deliveries and creating new growth drivers are what we deem to be more critical at the moment.
The writer is chief economist at China International Capital Corp. The views don't necessarily reflect those of China Daily.
