Why China’s funding cost has been rising



Funding cost has been rising in China

The funding cost is the price at which credit is available is the market. There are two main reasons why the real funding cost has been rising in China in recent months.

  1. As central bankers in China started implementing certain monetary policy tightening measures limiting the availability of credit, banks started differentiating between creditworthy and not-so-creditworthy customers. They would charge a higher nominal interest rate for selected borrowers to provide for the additional risk attached to their limited creditworthiness.
  2. Inflation in China has been declining. So, for a given nominal interest rate (on credit), the real cost of borrowing (nominal interest rate less inflation rate) has been rising.

However, with the economy continuing to slow, these tightening monetary conditions aiming at limiting credit availability are unwelcome. The authorities decided on further policy actions to counter the slowdown.

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China’s rate cut: A first in more than two years

On Friday, November 21, the People’s Bank of China cut the one-year lending rate from 6% to 5.6% and the one-year deposit rate from 3% to 2.75%. According to the bank, its decision to cut deposit and lending rates was designed to lower corporate borrowing costs.

The news benefited Chinese equity tracking ETFs like the iShares China Large-Cap ETF (FXI), the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR), and the iShares MSCI China Index Fund (MCHI). They gained 3.29%, 4.67%, and 2.87%, respectively, on November 21, 2014.

Since China is the second largest-economy, market-moving events in China also have repercussions in other parts of the world. The SPDR MSCI World Quality Mix ETF (QWLD) and the iShares MSCI ACWI Index Fund (ACWI) track global equities and are affected by any major global event.

To learn why regulators in China have been resisting a rate cut, read on to the next part of this series.


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