A New Era For Chinese Monetary Policy
- Chinese easing measures have been unimpressive so far.
- High debt levels rule out massive monetary stimulus.
- Economic crisis response now a job for propaganda officials and police.
One argument for staying long risk assets despite the coronavirus epidemic is that China may respond to this “black swan” event with a flood of new money, thereby creating a rising tide that will lift all boats. Some have argued that such a stimulus is already underway, pointing to record new lending by the Chinese commercial banks, the central bank’s liquidity injections in the repo market, and reductions to the required reserve ratio (RRR) and the interest rate on its medium-term lending facility (MLF). Yet much of the recent easing is not as impressive as it seems and Beijing has yet to signal a major policy shift.
Consider the 3.34 trillion yuan ($480 billion) lending record set in January, for example. While this appears at first glance to be a sign of dramatically easier credit conditions, in China, January has been the strongest month for new loans as far back as the pre-1978 command economy period. In fact, new lending also set a record in January 2019. This January’s loan growth came in at only 3.3% on a year-on-year basis. (See Figure 1.)
Figure 1. Monthly New Loans
The central bank’s record injection of 1.2 trillion yuan ($170 billion) through seven- and 14-day repo operations on February 3 was also less than meets the eye. Subtracting the 1.05 trillion yuan in repos maturing on that date, the net amount was a much less remarkable 150 billion yuan. And the latter half of the month saw net open market withdrawals as the 1.2 trillion was not rolled over. The objective was evidently to engineer a smooth post-Chinese New Year resumption of trading in the financial markets rather than to open the monetary floodgates.
January’s 50 basis point reduction in the RRR — the percentage of deposits the commercial banks are required to hold as reserves at the central bank — was similarly underwhelming. In China, RRR changes have more to do with exchange rate policy than with macroeconomic management. Central bank forex purchases designed to alleviate upward pressure on the exchange rate following capital inflows necessarily result in local money supply increases because the central bank must create yuan to pay for the foreign currency it buys. To avoid triggering a rise in inflation, the monetary authorities have typically “sterilized” this new money with RRR increases, thereby keeping the banks from lending it out. Such interventions necessitated a multi-year series of RRR hikes prior to 2012. Since then, the policy has gone into reverse with capital outflows being countered with RRR cuts. The central bank’s latest move looks more like a continuation of this pattern than anything else. (See Figure 2).
Figure 2. The Required Reserve Ratio
The recent ten-basis-point reduction in the one-year MLF rate was small by any standard and will be relatively ineffective as a stimulus measure. China’s private businesses generally have only limited access to bank finance and the investment decisions of the wholly or partially state-owned enterprises tend to be driven more by political considerations than net present value calculations.
A tidal wave of liquidity would in any event require more than conventional monetary policy tools. In the Chinese context, it would also require a relaxation in the prudential supervision of the financial sector, which would allow new money to flow through the state-owned banks into indiscriminate fixed asset investment. This is what happened, for example, in the wake of the 2008 global financial crisis, when Beijing’s 8% GDP growth target was achieved through massive state bank loans to property developers and local government infrastructure projects.
So far, there has been little evidence that the policymakers will follow this strategy again. The focus has instead been on relatively modest measures designed to lessen strains on small and medium sized enterprises and support industries relevant to fighting the epidemic. According to the official account of the February 19 meeting of the Politburo’s Standing Committee, the existing “prudent” stance of monetary policy will now be “even more appropriate and flexible.” But this signals only an incremental adjustment, not a switch to the “appropriately relaxed” stance of early 2009. This time, we are told, avoiding “systemic financial risks” is to be the Party’s “bottom line.”
Given the explosion in China’s corporate and local government debt over the past decade, this is not surprising. The Politburo can no longer afford to sacrifice financial sector stability for the sake of defending some particular level of GDP growth. Nor would such an approach really be consistent with Xi Jinping’s philosophy of “socialism with Chinese characteristics for a new era,” which replaces the promise of economic prosperity with ever more rigid forms of control as the primary means of maintaining social stability.
In the new era, economic crisis response is now more likely to be a job for propaganda officials and the police than for the central bank. If this is the case, anyone betting on an old school Chinese monetary stimulus will be in for a disappointment.
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