Nomura flags rising 2018 lending rates
INFLATION could overshoot the central bank’s target range in 2018 on the back of higher taxes and rising global crude prices, which could prompt the monetary authority to raise rates by as many as four times next year, analysts at Nomura Global Research said.
Bank analysts said their fresh estimates showed that overall price increases for basic goods and services could average 4.3% next year, well above the 2-4% target band of the Bangko Sentral ng Pilipinas (BSP).
If realized, this would also pick up from the 3.2% average expected this 2017 and would beat the central bank’s 3.4% forecast for the year.
In giving their latest forecast, Nomura economists factored in a higher oil price assumption of $65 per barrel, higher taxes under the tax reform package being finalized by Congress and a “more positive” output gap for the domestic economy.
“[W]e expect the bigger focus for 2018 to be headline inflation surprising the central bank target to the upside,” the global bank said in its Dec. 7 Asia Economic Outlook report.
The beyond-target pace will likewise prompt the central bank to adjust policy settings, the global lender said.
“We think BSP will not be able to look through the risk of headline inflation breaching its target in 2018. As a result, we now expect BSP to hike its policy rate by a total 100bp (basis points) to 4.0% at a rate of one 25bp hike per quarter,” the report read.
The BSP has kept its monetary policy stance unchanged since September 2014 amid manageable inflation and firm domestic demand, except for procedural cuts introduced in June 2016 for the shift to an interest rate corridor system.
The central bank is scheduled to hold its eighth policy review on Dec. 14.
On the other hand, Nomura said growth will further pick up to 6.8% in 2018 coming from this year’s projected 6.7%, boosted by faster global growth and a recovery of electronics exports. Philippine gross domestic product (GDP) growth clocked 6.7% in 2017’s first three quarters against the government’s 6.5-7.5% full-year target. Nomura now expects fourth-quarter GDP growth at 7.0%, after the accelerating 6.4%, 6.7% and 6.9% in the first to third quarters, respectively.
“… [O]ur fundamental view is that India, Indonesia and the Philippines are Asia’s new rising stars. We nickname them Asia’s ‘tiger cubs,’ replacing Northeast Asia’s aging and debt-burdened tigers as the core of the region’s economic dynamism…” the report read.
Zeroing in on the Philippines, it added that “[f]or next year, despite a likely increase in political noise, we expect the government’s focus on reforms to remain strong, alongside its drive to raise infrastructure spending further, which will be boosted by the reconstruction in Mindanao following the prolonged anti-terrorism military operations in Marawi” that ended in October after five months of siege.
BSP Governor Nestor A. Espenilla, Jr. has said that the central bank remains well-equipped to shield the economy against various risks that could fuel volatility in financial markets, but noted that domestic considerations remain the biggest concern for the monetary authority.
He has constantly said that the BSP does not have to move in sync with the United States even as another rate hike is in the offing from the Federal Reserve in the Dec. 12-13 meeting of its Federal Open Market Committee. — Melissa Luz T. Lopez
Stronger peso helps pare down Dec. Meralco bills
MANILA ELECTRIC Co. (Meralco) announced on Thursday a P0.3785 per kilowatt-hour (kWh) cut in overall electricity rate for December after five straight months of increases.
In a statement, the distribution utility said the decrease translates into an overall rate of P9.2487/kWh, down from November’s P9.6272/kWh.
It said the rate decrease this month amounts to around a P76 reduction in the total bill of a household using 200 kWh — Meralco’s biggest residential customer segment.
Those consuming 300 kWh, 400 kWh and 500 kWh will see corresponding reductions of P113.55, P151.40 and P189.25, respectively.
“The lower December rate is mainly due to a P0.3035/kWh reduction in the generation charge,” Meralco said, explaining that a stronger peso and lower charges at the Wholesale Electricity Spot Market (WESM) brought down the generation charge.
This month, Meralco said the generation charge dropped to P4.6045/kWh from P4.9080/kWh in November largely because of the peso’s appreciation and the lower WESM charges.
The listed company said despite a slight increase in the demand for power in Luzon during the November supply month, WESM charges dropped by P0.4658/kWh.
It said the power supply situation improved from October, when the grid experienced three instances of “yellow” alerts, a warning issued by the grid operator to signify thinning power reserves.
WESM purchases accounted for 12% of Meralco’s requirement in the November supply month, the company said.
Meralco said charges from independent power producers (IPPs) and power supply agreements (PSAs) also recorded a drop of P0.2191/kWh and P0.3244/kWh, respectively, which the utility attributed to the strengthening of the peso against the US dollar. “The peso-dollar exchange rate affects around 97% of IPP and 60% of PSA charges. IPPs and PSAs each provided 44% of Meralco’s total requirement,” it said.
Meanwhile, the transmission charge of residential customers went down by P0.0186/kWh.
As a result, taxes and other charges also slipped by P0.0564/kWh.
“Meralco’s distribution, supply, and metering charges, meanwhile, have remained unchanged for 29 months, after these registered reductions in July 2015,” the company said, as it reiterated that it does not earn from the pass-through charges such as the generation and transmission charges.
Payment for the generation charge goes to power suppliers, while the transmission charge goes to privately owned grid operator National Grid Corporation of the Philippines.
Taxes and other public policy charges, including the feed-in-tariff allowance, are collected by the national government.
Meralco’s controlling stakeholder, Beacon Electric Asset Holdings, Inc., is partly owned by PLDT, Inc. Hastings Holdings, Inc., a unit of PLDT Beneficial Trust Fund subsidiary MediaQuest Holdings, Inc., has interest in BusinessWorld through the Philippine Star Group, which it controls. — VVS
Foreign reserves decline for a third straight month to fresh two-year low
THE COUNTRY’s dollar reserves dipped anew in November to a fresh two-year low on the back of lower gold valuations and debt payments made by the national government, the Bangko Sentral ng Pilipinas (BSP) reported yesterday.
Gross international reserves (GIR) totalled $80.313 billion last month, down from October’s $80.419 billion and $81.451 billion posted in November 2016. The amount is also the lowest since the $80.173 billion logged in November 2015, according to central bank data.
International reserves are made up of gold, the BSP’s assets held in foreign currencies, country quotas with the International Monetary Fund (IMF) as well as foreign currency deposits held by government and state-run firms.
In a statement, the BSP attributed the decline in reserves to bigger outflows as the government paid off its maturing foreign currency debt, alongside lower gold valuations in the international market.
The value of the BSP’s gold holdings slipped to $8.046 billion compared to $8.065 billion the previous month. Still, the amount went up from the $7.402-billion valuation recorded in November 2016.
“These were partially offset by net foreign currency deposits of the national government and income from the BSP’s investments abroad,” the central bank said.
Foreign investments continued to account for the bulk of GIR at $65.244 billion last month, slipping from October’s $65.257 billion and down 5.4% from the $68.934 billion a year ago.
The BSP’s foreign exchange holdings also dropped to $5.393 billion from $5.462 billion in October.
The central bank sometimes uses the reserve fund to influence daily peso-dollar trading by buying or selling more units in a “tactical intervention” to temper exchange rate swings.
The peso averaged P51.0384 versus the dollar in November, recovering slightly as it traded at the P50 level against the greenback.
Funds parked with the International Monetary Fund (IMF) also declined to $440 million from $445 million in October.
The country’s special drawing rights — the amount which the country can tap in the IMF’s reserve currency basket — steadied at $1.191 billion. Amounts in the IMF basket are expressed in US dollar, Japanese yen, euro, British pound and the Chinese yuan.
Despite the lower GIR level, the reserve stash can still cover up to 8.4 months’ worth of import payments — well above the three-month international standard.
It can likewise pay up to 5.4 times the country’s short-term foreign debt when computed on original maturity, and up to 3.7 times based on residual terms (outstanding external debt with up to one-year maturity, plus principal payments on medium- and long-term loans of the public and private sectors falling due in the next 12 months.)
However, the foreign currency buffer settled below the $80.5 billion forecast given by the BSP for the entire year, and is already lower than the $80.692-billion GIR level at end-2016.
International credit raters and multilateral lenders have cited these reserves as a source of credit strength, as they help cushion the economy against external shocks. — Melissa Luz T. Lopez
SE Asian builders to reap gains from $323-B spree
BANGKOK/HANOI/JAKARTA/KUALA LUMPUR/MANILA/SINGAPORE — Tech is so 2017.
With at least $323 billion in infrastructure spending in the pipeline in Southeast Asia and potentially more expected over the next few years, 2018 could well shape up as the year of builders’ stocks from Indonesia to the Philippines that have been the laggards in a broader market rally this year.
Governments are boosting spending on everything from airports to high-speed rails and ports to increase connectivity and boost economic growth in what promises to be a boon for the region’s construction companies.
In one of the more ambitious programs in the region, Philippine President Rodrigo R. Duterte has earmarked an unprecedented $180 billion for infrastructure to keep driving one of the world’s best-performing economies over coming years.
Malaysia and Thailand are also ramping up allocations to public works ahead of general elections in 2018.
“Infrastructure has been under invested whether it’s clear water, clean air, energy, roads, ports, railways, education, health care — so there are tons of opportunities,” said Ashish Goyal, head of emerging markets equities at NN Investment Partners (S) Ltd. that manages $288 billion in assets.
The firm owns stakes in Indonesian construction stocks, he said, adding that investors should watch for the pace of execution in the various countries.
UBS Group AG expects “changes in government policy and delivery on infrastructure” to be among the region’s biggest themes for 2018 as growth in global trade fades, analysts including Ian Gisbourne wrote in a report dated Nov. 28.
Construction stocks on the MSCI ASEAN Index have risen an average of about 7.4% this year in dollar terms, about one-third the gain of the overall gauge, which is set for its best performance in seven years. Technology shares have provided the biggest boost to the Southeast Asian index this year as global demand for electronics returned.
Some builders are already rallying in anticipation of the rewards they will reap from the spike in infrastructure outlays. Indonesian cement supplier PT Indocement Tunggal Prakarsa soared as much as 54% earlier this year as investors expect it to benefit from a surge in demand as the nation builds toll roads, ports and power plants.
Manila-based EEI Corp. has surged 73%, leading a rally in Philippine construction stocks, as it begins work on the nation’s $1.6 billion, 44 kilometer (27 mile) mass-railway project.
Infrastructure development and more Chinese investments into the Philippines could support stocks with net asset value of the nation’s developers expanding by as much as 12% over the next three years, writes Goldman Sachs Group, Inc. analysts including Paul Lian in a report dated Dec. 7.
Companies that provide services for construction projects, such as improving management efficiency or sustainability, may also capitalize on the spending boom on public works, Felix Lam, a portfolio manager at BNP Paribas SA’s asset management arm, said by phone.
Even so, the Southeast Asian market as a whole might continue to underperform, compared to “its larger, more liquid and faster growing North Asia and India counterparts,” Goldman Sachs Group, Inc. analysts including Timothy Moe wrote in a November report.
And Credit Suisse Group AG has maintained its underweight rating on the region for 2018.
Still, Morgan Stanley sees investor attention back on the Asean region as markets are expected to give returns of as much as 10% next year, more than three times what’s seen for emerging markets.
Here is a breakdown of what countries are planning and what investors are saying about Southeast Asia’s infrastructure spending spree:
PHILIPPINES
The government has allocated about P1 trillion ($20 billion) to infrastructure in the 2018 budget as part of Mr. Duterte’s $180-billion infrastructure program over a six-year period to build a network of railroads and highways across the archipelago. Tax reform will help fund infrastructure projects; construction and infrastructure-related stocks to outperform in 2018, according to Noel S. Reyes, who helps manage $1 billion as chief investment officer at Security Bank Corp. Tax reform bill awaiting Congress approval and is among first of five tax packages proposed by Mr. Duterte to raise taxes to pay for infrastructure projects. Infrastructure program includes 70 projects from railways, airports, roads and bridges, cities, ports to mass transit during Mr. Duterte’s six-year term as president. Companies involved in construction and infrastructure include Metro Pacific Investments Corp., Megawide Construction Corp., Ayala Corp. and EEI Corp.
INDONESIA
Indonesia’s Finance Minister Sri Mulyani Indrawati has announced more than 240 infrastructure projects Country needs 931 trillion rupiah ($69 billion) from 2015 to 2019 for infrastructure spending; has allocated only 528 trillion rupiah over the period, according to Public Works and Public Housing Ministry. Concerns about funding availability and financing risks among Indonesian infrastructure companies have depressed construction stocks this year. Shares of PT Waskita Karya, the country’s biggest listed builder, have dropped 27% in 2017 even as the Jakarta Composite Index hit a record high in November. The country’s biggest construction companies include PT Jasa Marga, PT PP Persero and PT Waskita Beton.
MALAYSIA
Malaysia has allocated 210 billion ringgit ($51.6 billion) for projects in the 2018 budget of which 73% will go rail and public transport. About 55 billion ringgit allocated to East Coast Rail Link, 50 billion-60 billion ringgit given to Kuala Lumpur-Singapore High Speed Rail and 40 billion ringgit to phase 3 of the mass rapid transit system Rail, affordable housing, roads and water infrastructure are major segments that will benefit from government’s spending next year, Sharizan Rosely, an analyst at CIMB wrote in a report dated Oct. 30. The country has a general election due by August 2018. Biggest construction companies include Gamuda Bhd., IJM Corp. Bhd., Sunway Construction Group Bhd. and Malaysian Resources Corp. Bhd.
THAILAND
The government has pledged 1.5 trillion baht ($46 billion) over the next five years to boost growth via infrastructure spending to develop its three eastern provinces as the Eastern Economic Corridor (EEC). Infrastructure spending to remain key driver for the economy and new development projects such as EEC, said Orsen Karnburisudthi, Bangkok-based senior investment manager at Aberdeen Asset Management Co. EEC envisions to turn the provinces into hubs for technological manufacturing and services with strong connectivity by land, sea and air with help of state and private funding as well as foreign direct investment. Elections are expected to be a key upside for economic growth and business sentiment, Aberdeen said. Prime Minister Prayuth Chan-Ocha said in October a vote will be held in November 2018. Banks to see earnings improve as economic growth boosts loan growth and reduces bad loan provisions, while shopping mall operators and retailers can benefit from consumption recovery, Mr. Orsen said. Biggest construction players include Italian-Thai Development Pcl, CH. Karnchang Pcl, Unique Engineering & Construction Pcl, Sino-Thai Engineering & Construction Pcl as well as EEC beneficiaries: Amata Corp. and WHA Corp.
VIETNAM
Vietnam has allocated 150 trillion dong ($6.6 billion) for infrastructure development in 2016 to 2020 and still needs $480 billion to fund investments by 2020, according to the Ministry of Planning and Investment. Key infrastructure projects include a $13-billion, 1,800 kilometer expressway from Ha Noi in the north to Ho Chi Minh city in the south, the nation’s largest ever road project. The biggest infrastructure players include Songda Urban, Ho Chi Minh City Infrastructure, Coteccons Construction, Ha Do JSC and Song Da No. 9 JSC.
SINGAPORE
As the only developed market in Southeast Asia, Singapore is less likely to see government expenditure in infrastructure on the same scale as its neighbors. While some key projects for 2018 include a new airport terminal at Changi Airport, mega shipping port and the KL-Singapore high-speed rail, the country’s stock market is more likely to benefit from a recovery in the property sector and overall economy. DBS Group Holdings Ltd. sees property prices recovering 3-5% annually over the next two years, buoying small to mid-cap construction-related and real estate stocks such as Chip Eng Seng Corp. and APAC Realty Ltd., analysts including Ling Lee Keng wrote in a note dated Dec. 5. Singapore’s economic recovery is also seen broadening out from the manufacturing industry in 2018 to the services sector, which accounts for about two-thirds of gross domestic product. — Bloomberg
Shell focused on tax fight, not Malampaya extension
By Victor V. Saulon, Sub-Editor
MALAMPAYA’S natural gas reserves can last up to 2029, the operator of the country’s offshore gas-to-power project believes, but its focus for now is not a contract extension beyond 2024 but its pending tax case with the government.
“Based on what we know… depending on the drawdown there will still be gas until 2027 to 2029,” Cesar G. Romero, Pilipinas Shell president and chief executive officer, told reporters on the sidelines of a media event hosted by the company on Wednesday night.
The often-cited timeline of 2024 “does not mean the field is zeroed out,” said Mr. Romero, who also chairs all Shell companies in the Philippines.
Shell companies in the Philippines include Shell Philippines Exploration B.V. (SPEx).
SPEx and consortium partners Chevron Malampaya LLC and PNOC Exploration Corp. operate the Malampaya natural gas platform, which fuels several power plants in Batangas and supplies Pilipinas Shell’s refinery and compressed natural gas refilling station. The project delivers about a fifth of the country’s electricity requirements.
In July last year, SPEx filed a new arbitration case against the state before the International Centre for Settlement of Investment Disputes, a World Bank-backed independent dispute-settlement institution based in Washington D.C.
SPEx, a unit of Anglo-Dutch company Royal Dutch Shell plc, previously challenged the interpretation of the Commission on Audit (CoA) in the computation of the 60-40 sharing of the proceeds from the Malampaya project.
A 2009 report of the CoA found P53.14 billion of underpayments involving corporate income taxes due from the Malampaya consortium.
Under previous administrations, the Department of Energy (DoE) held the position that the tax liabilities had been covered by the 60% share remitted by the agency from 2002 to 2009. But the state auditor maintained that the consortium members underpaid their taxes. The dispute resulted in SPEx previously seeking arbitration in Singapore.
“Any action we think about at the moment is put on hold because we have to sort out CoA first,” Mr. Romero said.
“2024 is still a long time. Hopefully we’ll be able to work something out with the government and CoA reverses its decision,” he added.
Sought for comment, Energy Secretary Alfonso G. Cusi did not directly respond to Shell’s comment on Malampaya’s productive life. But he said the government’s plan to build an integrated liquefied natural gas (LNG) facility at a cost of around $2 billion would go ahead even if the Malampaya contract is extended beyond 2024.
“That’s part of [energy] security,” he said.
On Thursday, Mr. Cusi told participants at an energy industry forum that he believes there is an opportunity for the Philippines to benefit from an expected surge in LNG supply because of the country’s strategic location. He said a huge number of ships and vessels already pass through the country via Subic.
“If we plan ahead, we can be the gateway for future gas exports into Southeast Asia,” the DoE chief said.
Peso up ahead of US jobs data
THE PESO moved sideways against the dollar on Thursday due to profit taking ahead of the US non-farm payrolls data.
The local currency rose to P50.65 against the greenback yesterday, gaining six centavos from its P50.71-per-dollar finish the prior day.
The peso opened weaker at P50.77, while its worst showing for the day stood at P50.81 versus the dollar. It closed at its intraday high.
Dollars traded surged to $706.6 million yesterday from $599.2 million the previous day.
“Dollar-peso traded lower at P50.65 due to profit taking ahead of the non-farm payroll data,” a trader said over the phone.
Meanwhile, traders said yesterday’s close was within range, with another trader adding that the peso traded mostly within the P50.73-to-P50.77 level.
“Investors have been looking for fresh new leads but found none,” Ruben Carlo O. Asuncion, chief economist of UnionBank of the Philippines, said in an e-mail.
A trader added that there were some flows from offshore markets.
“In fact, onshore, we didn’t see any flows from our end; we just heard there might be some inflows from the offshore markets,” the trader said.
“Towards the end, we just saw a lot of players just tried to sell down when dollar-peso was already trying to close higher.”
Another trader attributed the slight strengthening of the peso to the “fears of possible US government shutdown should the US Congress fail to pass the federal budget within the week.”
Back home, Mr. Asuncion noted that market players will also watch how the bicameral conference on the tax reform bill will pan out.
For today, a trader said the peso-dollar exchange will play within P50.60 to P50.90, while another trader gave a higher range of P50.50 to P50.80.
“The peso is expected to strengthen due to likely stronger Eurozone [third] quarter GDP (gross domestic product) and expected hawkish remarks from Mario Draghi’s speech [yesterday] but may be capped by positive developments on the US tax reform bill,” a trader said.
Other Asian currencies drifted on Thursday, with investors shying away from risk ahead of key central bank meetings next week and due to political uncertainty in the Middle East.
Market players expect the mood to be cautious in the run-up to next Thursday, when both the US Federal Reserve and the European Central Bank are expected to hold policy meetings.
Elsewhere, US President Donald J. Trump on Wednesday reversed decades of US policy and recognized Jerusalem as the capital of Israel, imperilling Middle East peace efforts and upsetting the Arab world and Western allies alike. — K.A.N. Vidal with Reuters
Manila Water bags Leyte project
MANILA WATER Company, Inc. on Thursday said it has bagged a project to build and manage the water supply and sanitation facilities in Leyte.
In a disclosure to the stock exchange, Manila Water said it received the notice of award from Leyte Metropolitan Water District (LMWD) for the joint venture project for construction, rehabilitation, maintenance, operation and management of water supply and sanitation facilities in the latter’s service area.
“Manila Water’s proposal includes the following: development of interim and long term sources, expansion of distribution network, reduction of nonrevenue water and development of sanitation services,” the Ayala-led company said.
Manila Water said the notice included a condition for the creation of a special purpose vehicle (SPV) to implement the project under a joint venture with LMWD.
“Upon completion of the conditions precedent specified in the Notice, the SPV and the LMWD shall enter into a joint venture agreement that will grant the SPV, as contractor to perform certain functions and as agent for the exercise of, the sole and exclusive right to manage, operate, maintain, repair, refurbish and improve, expand and as appropriate, decommission, the facilities of LMWD in its Service Area,” it said.
LMWD’s service area includes Tacloban City and seven municipalities namely, Palo, Tanauan, Dagami, Tolosa, Pastrana, Tabontabon, and Santa Fe, with an estimated population of 483,000.
LMWD said in 2016 it had over 31,000 water service connections with a billed volume of 27 million liters a day.
In October, Manila Water said its joint venture with Obando Water District signed a 25-year concession agreement to develop the water supply system of Obando, Bulacan.
Manila Water previously said the Obando project is line with its aim of bringing its expertise in water and used water services outside of its Manila concession.
For the first nine months of 2017, Manila Water’s net income attributable to the parent was flat at P4.89 billion.
Operating revenues went up 3% to P13.78 billion during the January to September period, driven by the billed volume growth of the Manila concession and the expansion of its local subsidiaries. However, operating costs and expenses grew 11% to P4.9 billion due to the increase in both volume and price of water.
Manila Water provides water and wastewater services to Metro Manila’s east zone concession area covering the cities of Makati, Mandaluyong, Pasig, Pateros, San Juan, Taguig and Marikina. It is also in charge for the southeastern parts of Quezon City and Sta. Ana and San Andres in Manila.
Shares in Manila Water rose 0.53% or 15 centavos to close at P28.65 each.
China’s banks need more capital after credit boom
CHINA’S banks should increase their capital buffers to protect against any sudden economic downturn following a credit boom, the International Monetary Fund (IMF) said.
In its first comprehensive assessment of China’s financial system since 2011, the IMF recommended “a gradual and targeted increase in bank capital.” In a worst-case scenario, IMF stress tests suggested the country’s lenders would face a capital shortfall equivalent to 2.5% of China’s gross domestic product (GDP) — about $280 billion in 2016 — together with ballooning soured loans.
Overall, 27 of 33 banks stress-tested by the fund, covering about three quarters of China’s banking-system assets, were under-capitalized by at least one measure. A larger financial cushion would better reflect potentially underestimated risks stemming from the banks’ exposure to opaque investments, and absorb losses as implicit government guarantees are removed, the fund said.
China’s top four banks, led by the world’s largest lender by assets Industrial & Commercial Bank of China Ltd., have enough capital, the fund said. But it said the nation’s smaller lenders, including those focused on individual cities “appear vulnerable.”
DISPUTED RESULTS
The findings reflect the burden on a financial system that’s doubled in size in 10 years while China evolves from an export-oriented economy to one based on services and consumption. The call for capital highlights the risks during that transition caused by government policies aimed at protecting jobs or propping up failing state entities.
“Stress test results reveal widespread under-capitalization of banks other than the Big Four banks under a severely adverse scenario,” the fund said in its report. “Increasing capital would enhance the resilience and credibility of the financial system, as well as reassure markets.” The fund didn’t name the specific banks that need more capital.
Responding to the report, the People’s Bank of China said the assessment was generally fair but disputed the IMF’s interpretation of the stress test results.
“Comments about the stress test in the report do not fully reflect the results of the tests,” the central bank said in a statement on its website Thursday. “China’s financial system has shown relatively strong capability to cope with risks.”
FINANCIAL STABILITY
President Xi Jinping has highlighted financial stability as a top priority. People’s Bank of China (PBoC) Governor Zhou Xiaochuan warned in October about the risk of a ‘Minsky moment,’ or a sudden collapse of asset values. Financial watchdogs last month promised to overhaul regulation of asset-management products, which hold about $15 trillion and are seen as a key threat to stability.
Speaking to media on Thursday on a video call, the IMF’s deputy director of monetary and capital markets, Ratna Sahay, said China’s financial system held three main risks. She pointed to an increase in credit that in other countries has been linked to financial distress. An increasingly complex and opaque financial system makes it hard to identify risks, and implicit guarantees encourage excessive risk-taking, she said.
Credit growth needs to slow, guarantees should be gradually removed, and banks need more capital during that process, Sahay said. “Banks need to have some buffers in order to protect against any possible distress that might happen,’’ she said.
‘MANAGEABLE’ SHORTFALLS
While bank capital shortfalls “appear manageable,” the fallout from any deleveraging process could amplify the need for funds, the IMF said in its report. In a “severely adverse scenario,” the capital shortfall at 33 banks tested by the fund could amount to 2.5% of GDP, it said.
“We are talking about capital shortfalls in a stress-testing scenario,” Sahay told Bloomberg Television’s Kathleen Hays in an interview. “It’s in that scenario, it’s not the current situation. They are moving in the right direction, they understand that the risks are large and they are mitigating them.”
China’s credit growth has outpaced expansion in GDP, and the credit-to-GDP ratio is now about 25% above the long-term trend, the IMF said in its report. Such a level is “very high by international standards and consistent with a high probability of financial distress,” the fund said.
The official proportion of non-performing loans at banks — 1.7% in the second quarter of 2017 — may understate the reality, the IMF said. The true extent of soured loans at Chinese banks has been debated by analysts and investors for years. The People’s bank of China said Thursday the ratio has stayed low because banks have written off bad debts.
Under the IMF’s “severely adverse” scenario, the non-performing loan ratio at the 33 tested banks jumps to 9.1% from 1.5%, and their common equity Tier 1 capital ratio, a benchmark gauge of financial strength, plunges 4.2%age points. Banks would be unable or unwilling to maintain their pace of lending, and the fiscal impact might exceed the direct recapitalization needs of the banking system “by a wide margin,” the IMF said.
The dangers in removing implicit guarantees in China — the belief among investors that the government will compensate them for losses — and the risks posed by off-balance sheet items also justify higher levels of capital, two of the report’s authors, Sahay and James P. Walsh, said in a separate article accompanying the report’s release. Wealth management products (WMP), hugely popular investments that offer superior yields to traditional bank deposits, make up a large proportion of China’s shadow banking sector.
WMP RISKS
“Off-balance sheet WMPs also represent a significant risk to capital,” the report said. “They are not guaranteed, but banks almost always compensate retail investors for principal losses. In a stress scenario, the costs to the banks of supporting WMPs could be substantial and could, in case of a run, place the liquidity position of some banks under strain.”
The IMF also ran stress tests to assess liquidity at China’s banks. While conditions at China’s four big banks were strong, the tests showed that four banks would suffer liquidity shortfalls within 30 days, the IMF said. Late Wednesday, China’s banking regulator unveiled new liquidity thresholds for small banks, saying it needed to fill a gap in its supervision.
Authorities need to put less focus on high GDP projections, and better supervise financial conglomerates and reforms to tackle implicit guarantees, the IMF said. But allowing firms to fail and investors to lose money will be challenging.
“Credit growth will not slow sustainably unless tolerance for job losses and slower economic growth rises, particularly at local level, and new sources of revenue are found for local governments,” Sahay and Walsh wrote in their article.
BORROWING SURGES
Total borrowing will climb to around 328% of gross domestic product by 2022 from around 260% in 2016, according to Bloomberg Economics. The economy likely grew at 6.8% in 2017, comfortably meeting the government’s target for growth of about 6.5%.
Improved coordination and communication between regulators is needed and the People’s Bank of China and other regulators need a substantial increase in staffing, the IMF said.
“The staff count at headquarters of the PBoC and the regulatory agencies has not risen in 10 years, while the financial sector has doubled in size,” the IMF said in its report. — Bloomberg