Yesterday, China released manufacturing PMI figures which showed that June manufacturing expanded at its fastest pace this year, adding to signs that the government’s efforts to stabilise the economy is working.

PMI figure at its highest this year
According to China’s National Bureau of Statistics and the China Federation of Logistics and Purchasing, China’s June Purchasing Managers’ Index (PMI) was at 51.0, in line with Bloomberg’s estimates and an increase from May’s 50.8. The PMI figure is also at its highest in six months.
 
The figure lends support to the effectiveness of recent pro-growth policies announced by the Chinese government. 

China eases loan-to-deposit ratio calculation
In the latest pro-growth measure, China regulators announced on Monday changes in the way loan-to-deposit ratios (LDR) are devised to give commercial banks more capacity to lend money. Macquarie Equities Research (MER) views this as another mini-stimulus measure in boosting bank loan growth and also a step toward interest rate liberalization.
 
In a research report published on Monday, MER made the following observations:

Easing LDR to boost bank loans: The aggregate LDR for commercial banks for 1Q14 was 65.9%, up from 64.5% as of end-2010. However, some joint-stock banks have already been close to the upper limit. For example, the LDRs for China Merchants Bank and Citic Bank reached 76.8% and 73% in 1Q14, respectively. Therefore, the loosened LDR requirement will ease the constraints faced by these banks and boost their lending capacity.
 
Lending quota in 2H to be raised, due to the weakness in FX purchases and shadow financing this year, bank loans are set to play a more important role in 2H14. Now with the LDR calculation revised by the China Banking Regulatory Commission (CBRC), MER thinks the next move will be for the Peoples’ Bank of China (PBoC) to raise the banks’ annual loan quota. MER expects Beijing to tacitly increase this year’s loan quota to RMB11tn from RMB8.9tn in 2013. Indeed, new loans started jumping in May. 
 
A step toward interest rate liberalization. One highlight of Monday’s revision is that certificates of deposit (CD) issued to firms and individuals will be counted as deposits. Note that Chinese banks haven’t been officially approved to issue CDs to firms and individuals. Nonetheless, media recently reported that Bank of China has already issued them on a trial basis. The interest rate for a one-year CD is reported to be around 4.2%, higher than the time deposit cap of 3.3% and lower than the yields of wealth management products (WMP) at around 6%. However, CDs are more liquid than WMPs because they could be traded in the market.
 
Revision on loan calculation points to targeted easing: First, re-lending loans to small- and micro-businesses will be excluded, indicating the government’s continued supports to SMEs. Second, loans backed by short-term financial bonds (less than one year and cannot be repaid early) will be excluded. As such, banks could issue more financial bonds to make loans in supporting social housing construction.
 
In MER’s view, LDR should be scrapped: The 75% LDR requirement, introduced in 1994, has been increasingly incompatible with the current situation. First, the requirement has caused fierce competition for deposits among Chinese banks, contributing to the surge of wealth management products in recent years. Moreover, the calculation measures only the sheer size of loans and deposits but ignores the quality and liquidity of various loans and the stability of various deposits. MER expects China to revise its Commercial Bank Law to replace LDR with a better liquidity coverage measure for banks.

Source: Macquarie Research - 2 Jul 2014