As China floods the economy with stimulus to boost growth, can it avoid US levels of inflation?
- While the PBOC resisted following the US Fed in enacting monetary easing at the start of the pandemic, it must now change course to meet its ambitious 2022 growth target of 5.5 per cent
- As the Fed prepares to tighten policy to tackle high inflation, it may be a sign of things to come for Beijing
A key moment from Premier Li Keqiang’s press conference to end the annual “Two Sessions” legislative meetings was his explanation of the new economic growth target.
While the market expected a figure of 4.5 per cent for 2022, Beijing instead announced a notably ambitious 5.5 per cent target, ahead of my own expectation of 5 per cent.
While light on details, Li indicated that policy to drive growth would include some tax reductions and employment support. Monetary policy will also be central to this effort.
We have already seen substantial divergence in monetary policy between China and the US since the start of the pandemic, but we can expect an even wider gap this year as Beijing policymakers shower the economy with stimulus to meet the government’s high bar, all while the US Federal Reserve tightens monetary policy to tackle inflation.
Two years ago, central banks across the world enacted extraordinary monetary policy to mitigate the effects of the pandemic. Back then, a nascent interest-rate-rising cycle at the Fed came to a screeching halt as the virus spread. Rates were slashed and aggressive quantitative easing was brought back, coupled with large fiscal policies.
These programmes were effective in putting a floor under the financial damage Covid-19 would ultimately cause, but this success was achieved at the cost of inflation.
Contrast this with what the People’s Bank of China (PBOC) did in 2020. Before Covid-19, monetary policy was focused on broad deleveraging and macroprudential reforms (i.e. the “three red lines” to limit real estate leverage).
No additional asset purchase programmes were launched in 2020 even as the pandemic exploded; the PBOC essentially tinkered with policy to create more favourable conditions for commercial bank lending and liquidity.
Despite Covid-19 hitting domestic consumption throughout 2020, there was no clear shift in Chinese monetary policy until December, with reductions on interest rates on short-term reverse repos and the medium-term lending facility, and on the reserve requirement ratio for commercial banks.
This enabled money and credit growth to expand, but considerably less than in the US. In 2020, China’s M2 money growth clocked in at 10.1 per cent year on year, versus 24.8 per cent in the US. The divergence narrowed to 9 per cent against 12.9 per cent in 2021.
This also resulted in much lower inflation; whereas the US figure in January 2022 stood at 7.5 per cent, in China it was only 0.8 per cent.
With the Fed now accelerating its tapering of asset purchases and ready to start a new rate rising cycle, the contrast with China couldn’t be starker.
The PBOC’s current approach simply isn’t sufficient to reach its 2022 GDP target, as the challenges facing the Chinese economy come into clearer focus.
Despite the current Omicron outbreak on the mainland, I believe the government can contain the infections, and the zero-Covid policy will remain in place until a home-grown mRNA vaccine and effective treatments are broadly available. This is likely to happen sometime this year, but domestic consumption won’t rebound to pre-Covid-19 levels until afterwards.
The massive property sector remains under pressure, but like zero-Covid, the three red lines policy isn’t going anywhere for the foreseeable future. Even though the government has made clear it does not see real estate speculation as healthy for the economy, it could nonetheless relax property restrictions, given that we’ve seen some stabilising of home prices, which could indicate the credit cycle has bottomed out.
This year’s GDP target will also need to be supported by robust infrastructure stimulus at a local level. Provincial governments have historically been a large driver of borrowing for major infrastructure projects – there are some indications this is picking up, for example in renewed spending on metro systems.
Regardless, a supportive monetary backdrop isn’t enough to boost the economy sufficiently – businesses will need to respond with increased credit appetite to fund real commercial activities. So far, there have been mixed signals on this; bank lending actually slowed slightly in January versus last September, although credit data demand showed a slight improvement in the fourth quarter of 2021.
As always, sustainable growth comes from economically productive investments. Spending will continue to flow to high-end manufacturing, technology, alternative energies, services and a strong domestic consumption base.
How long can the stimulus continue without a concerning rise in inflation? The war between Russia and Ukraine has thrown a wrench in this calculation with a rapid rise in commodity prices and a major repricing of risk.
Faced with similar challenges to the Fed, the PBOC must also navigate massive economic forces that are conspiring to complicate well-laid plans. Given that China has almost always met or exceeded its GDP growth targets, history is on its side.
Author: David Chao, SCMP