TWO POSITIVE SIGNALS FROM THE ORIENT

During the weekend, two developments in China and Japan have happened, which on paper at least augur well for the markets.

1.   China frees lending rates

Late last Friday, People’s Bank of China announced that it would scrap controls on lending rates and let banks price their loans by themselves.

The expectations were that the central bank would reduce rates but no one had expected the central bank to take out the floor. Earlier banks could not charge less than 30% of the benchmark rate set by the central bank.

This means that companies could get access to cheaper loans and profitability of companies could become better.

While the lending rates have been freed, the deposit rates still continue to be governed by the central bank. Currently banks in China cannot offer rates that are more than 10 percent above the PBOC-set deposit rates. Currently one year deposit rate is 3%.

Banks have so far enjoyed cheap funding. The day the deposit rates are freed, the banks will see erosion in their margins. So this is unlikely to happen quickly.   

Readers would recall that liquidity crisis had almost brought down China’s largest bank, ICBC. Another bank, Bank of China had almost reached the brink, before central bank aid pulled it out.

One of the reasons Why the Chinese Central Bank has not freed deposit rates is that a huge deluge of money will come in seeking higher rates, making currency rate management an issue.

One paper the reduction in rates is positive but will not work unless deposit rates are freed too.

2.   Japan: Abe’s party wins the upper house

Premier’s Abe’s part, LDP, is likely to gain majority in the upper house of the Parliament, exit polls suggest. LDP already has a majority in the lower house of the Parliament.

This will empower the Prime Minister Abe to carry out his mandate. Ahead of the elections, there was a 60% approval rating for Abe’s monetary easing and fiscal spending.

The parliamentary grid lock that has prevented previous governments from taking tough action has now ended. LDP should not only be able to move ahead with its easing but also take some unpopular steps that are necessary for the economy.

 Among the contentious issues that the premier will now have to navigate with majorities in both houses is the Trans-Pacific Partnership free trade talks that Japan will join this week. Abe has vowed to maintain a range of agricultural tariffs to protect Japan’s farmers.

With a larger majority under his belt, Abe could now flex his muscles on some of the contentious issues like reinterpretation of the constitution to end a self-imposed ban on exercising the right of collective self-defence.

Japan could move to acquire the capability to attack enemy bases when an attack is imminent and no other options exist. It could also move forward to create Marines division to protect remote islands.

For the Japanese markets, the development is good as the ruling party now has majority in both the houses.