China Review: China Mulling Floating Deposit Interest Rate

Manufacturing under pressure, headwinds for steelmakers and the central bank mulling a floating deposit interest rate

Dan Su, CFA 08 September, 2010 | 0:00
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China Launches New Interbank Online Payment System

China's central bank last week rolled out an ambitious interbank system linking the online platforms of major banks. Currently, the system is in trial operation in major cities such as Beijing, Guangzhou, and Shenzhen, but it will be covering the whole country soon. The new system provides a unified platform with easy access to account information and payment clearance, to facilitate easier interbank fund transfers at lower costs for corporate and retail customers. It enables users on the banking website of one bank to access information of their accounts at all other banks on the system at once and do real-time interbank transfers. Previously, users had to log-in to each bank account separately, and wait 1-2 days for the transfer to take place. Over the longer term, we think the interbank payment system should lead to lower bank transfer fees, although the fee schedules published by Bank of China last week reflected no such reduction yet.


Online banking has been booming in China for the past decade, but banks adopted different systems for security and payment clearance, making balance enquiries and transfers both cumbersome and expensive. Innovation is lacking as well. Some customised services were available for large corporate clients, but smaller businesses and individuals were largely left to their own devices, with many forced to turn to third-party payment systems that thrived in recent years. E-commence firm Alibaba, for instance, runs a popular payment system called Alipay that provides services similar to PayPal and claimed to have 200 million user accounts in July 2009. According to researcher Analysys International, third-party payment platforms processed CNY 600 billion worth of transactions in 2009 and CNY 455 billion in the first six months of 2010.


We believe the interbank system should help commercial banks deliver more convenient services and keep their customers on the banking sites longer, thus diminishing the appeal of third-party systems that are still perceived as somewhat less reliable. However, to remain competitive for the longer term, we think the banks should catch up on innovative new services that keep up with user demand and match those offered by third-party systems. Effective September 1, China will require all third-party payment systems to apply for a business licence, putting them under regulation. Some of them may become even more formidable rivals to the banks, as we expect that better transparency in the previously murky business of third-party payment will improve user confidence and help bring in more customers.


Market Recap

Better PMI in August boosted the stock market in China, although weakening global demand remained a concern. Investors were also worried about continued tightening in the property sector and a potential rate increase in the near future. The Shanghai stock index rose 1.7% for the week, while the Shenzhen index rose 3.9%.


Macro and Industry Updates

Higher August PMI Alleviates Worries of an Abrupt Slowdown

China's official purchasing managers' index (PMI) rose to 51.7 in August from 51.2 in July, reversing a downward trend that had dominated for the past three months. The index has consistently stayed above 50 (indicating expansion) since March 2009, but slipped to a 17-month low in July, sparking fears of a major slowdown in the manufacturing sector.


The August reading suggests a mild pick-up in activities, as supported by higher sub-indices for output, new orders, and order backlog. Inventories, procurement, and employment fell though, indicating fragile confidence in the near-term outlook. In the coming months, we expect the manufacturing sector to remain under pressure, as China continues to rein-in credit growth, curb speculation in the property sector, and remove excess capacity in the energy-intensive, high-pollution industries as part of the economic restructuring. Weakening demand in the US and European markets will be another drag on the growth of the sector, in our opinion. The launch of affordable mass-housing projects and infrastructure building in some inland regions may provide some relief, but we expect the impact to be limited.


Central Bank Mulling Trial of Floating Deposit Interest Rate

Recent comments from the central bank officials pointed to a possible floating deposit interest rate to be tried in northeastern China pending approval from the State Council.


If implemented, this move should help address the problem of a negative real interest rate for much of this year that has stalled deposit growth at all of the banks. However, the market is worried that floating rates will push up deposit interest rate and lower net interest margin (NIM), which now ranges from 2.1% to 3%. In our opinion, the negative impact on NIM should be less than the market expects, as banks were already implicitly offering better rates in their recent scramble to attract deposits and meet the loan-to-deposit requirement set by regulators.


Headwinds for Steelmakers in 2H Despite Slightly Lower Iron Ore Prices

Vale has confirmed a 10% cut in iron ore prices to $135/ton starting in October, but the new price will still represent a 42% year-over-year increase, offering little help to the Chinese steel mills battered by high material costs, overcapacity, and falling prices. Major steelmakers saw their margins shrink over the past year, while many small local mills shut down or were acquired. For the first half of 2010, gross margins at 77 large steel mills were only 3.47%.


In the second half, we expect steel demand in China to remain weak given the ongoing clampdown in the property sector, which represents more than 35% of steel demand in China. With August domestic steel inventory remaining high at 1.2 months of sales, we expect pricing pressure to persist in the coming months. We think government projects such as mass housing and high-speed rail may provide some boost to demand later in the year, and some inventory restocking may take place in the fourth quarter to bring moderate margin improvements to steelmakers.



Morningstar equity analysts Iris Tan, Zhao Hu and Hua Ye contributed to this article.


This is an edited version. The article originated from

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Dan Su, CFA  Dan Su, CFA, is a senior stock analyst with Morningstar.

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