PBOC Sticks to Limited Stimulus Even as China’s Outlook Darkens

  • Latest moves include rate cuts and guidance for bank lending
  • PBOC remains shy of major stimulus in line with new priorities

China’s property market crisis is testing whether central bank Governor Yi Gang can stick to his stimulus-lite strategy.

Over the past couple of weeks, Yi has cut key lending rates, announced special loans to struggling property developers via policy banks and urged state-owned lenders to extend more credit. Meantime, speculation of a cut to reserve requirement ratios grows.

Even with the raft of recent moves, there’s still a focus on containing risks. That’s in line with Premier Li Keqiang and the State Council’s cautious policy mindset that states the country won’t “overdraw the future.”

PBOC’s Restraint

China has refrained from drastic rate moves, unlike the US and Europe

It’s a “fine line that the PBOC has to walk,” says Hui Feng, co-author of “The Rise of the People’s Bank of China” and a senior lecturer at Griffith University. “Although growth has been lackluster, the central bank fears monetary stimulation would only lead to higher leverage in the economy with a higher cost than benefit.”

Economic challenges are piling up as China prepares for the 20th Party Congress, where President Xi Jinping is set to be endorsed for a precedent-defying third term. The property market is in a slump, Covid Zero restrictions are sapping consumer confidence, and the annual growth target will be missed by a wide margin for the first time since they started being set in the early 1990s.

What Bloomberg’s Economists Say

“Monetary easing alone may not be sufficient to revive demand, which has been shattered by the housing slump and Covid Zero restrictions. Restoring business and consumer confidence will probably require a more significant policy reorientation.”

Eric Zhu, China economist

Yi has recently promised monetary policy will remain “accommodative” to support the economy, but there’s an implied limit to how far the PBOC will go. In the past, he has argued against quantitative easing and avoided deep interest rate cuts, preferring more targeted tools.

Financial institutions, especially major state-owned banks, should increase loan issuance to the real economy, the PBOC said in a statement late Monday following a meeting chaired by Yi.

He has also ramped up the provision of targeted liquidity to support priorities such as technology innovation and the elderly care sector. Such so-called structural tools now total 5.4 trillion yuan ($793 billion), from about 3 trillion yuan five years ago.

Tame Inflation

The fastest inflation in over four decades seen in the US and other Western economies — in contrast with tame domestic prices — is partially vindicating Yi’s targeted approach.

China has “insisted not to overstimulate or print excessive amounts of money, and that has laid a solid foundation for maintaining stable prices — a hard-earned accomplishment,” the PBOC said in the latest monetary policy report this month.

But right now, the PBOC’s cautious approach appears to be running into a wall when the economy’s demand side is so drastically weakened by restrictions to stop Covid infections and the downward spiral in the property sector.

Companies are reluctant to expand investment under Covid-induced uncertainties and after a regulatory storm that upended industries including private tutoring and internet platforms. Defaults by property developers and an increase in stalled housing projects continue to plague the industry that once drove almost 40% of overall lending.

The result is that cheaper money and ample credit supply has failed to lead to stronger borrowing, increasing the risk of a “liquidity trap,” where lower interest rates aren’t able to spur more credit demand and economic growth.

New Development Phase

Yi’s monetary caution gels with President Xi’s assertion that China has entered a “new development phase,” where priorities including ensuring national security, narrowing income inequalities and maintaining social stability eclipse unfettered economic growth.

Economic development needs to be greener, more balanced and propelled by technological innovation and structural reforms that result in greater productivity and efficiency, according to Xi, instead of being driven by unsustainable and dangerous debt binges fueled by cheap money.

Stability Trumps

The PBOC sees risk prevention a top priority after post-2008 debt binge

Given Xi’s new imperatives, the PBOC is unlikely to embark on an outsize stimulus as it did in the wake of the global financial crisis in 2008 or again when a surprise yuan devaluation shook confidence in mid 2015. Such moves would undermine progress over the past five years in defusing a debt bomb that permeated sectors including the property industry, local government finances, shadow banking, consumer finance and big conglomerates.

Indeed, even if Yi wanted to, he couldn’t take major easing measures unless Xi agreed. Unlike global peers that enjoy a high degree of independence from their governments, the PBOC needs to get the nod from the State Council before it makes big decisions on money supply and interest rates.

Like almost every arm of government in China, there’s also a layer of Communist Party oversight, with Guo Shuqing, head of the banking and insurance regulator, the party chief of the PBOC. Yi, the deputy party chief, is responsible for the day-to-day operations.

State Control

While less independent than global peers, Yi in other ways wields more power because many parts of the economy are still not yet liberalized from the state’s control even after four decades of market reforms. That includes the vast $56 trillion banking sector, which is comprised mostly of state-led lenders and regional banks closely linked to local governments.

The PBOC exerts great power over the pace and direction of bank lending, as well as the cross-border capital flow, through a so-called macro-prudential assessment system established over the past decade. The system aims to maintain financial stability and contain the accumulation of debt and “pro-cyclical risks.”

The central bank regularly monitors banks’ business metrics such as capital adequacy, leverage ratios and credit growth rates. It punishes and rewards banks based on the assessment result, approves banks’ annual loan quota, and gives banks the so-called window guidance on their operations when needed.

The deleveraging campaign has moved the PBOC toward “quantitative measures and window guidance rather than price-based instruments,” according to Hui. “Space for liberal policies from the PBOC has been rather limited.”

The MPA system is now part of the PBOC’s “dual-pillar policy framework,” with the other component being the monetary policy mandate. A sweeping overhaul of financial regulatory agencies in 2018 also gave the central bank more power to rein in risks and cemented its status as a top financial regulator that coordinates various government bodies.

De-risking Campaign

Amid that regulatory overhaul, financing from shadow banking that takes place outside the traditional banking system has plummeted to 18 trillion yuan from a peak of 28 trillion yuan in 2018, according to PBOC data. The peer-to-peer lending industry has been nearly wiped out after a multi-year crackdown and regulation of internet finance has also increased, most notably with the shock last-minute suspension of Ant Group’s $35 billion initial public offering late in 2020.

The screws were also tightened on a clutch of conglomerates that engaged in aggressive borrowing and overseas expansion and controlled by powerful billionaires, such as Anbang Insurance Group, Dalian Wanda Group and Tomorrow Holding Co. Some of the firms and their subsidiaries were restructured and nationalized.

Meanwhile, banks have been directed to boost their capital by selling more bonds since the PBOC seized the Bank of Baoshang in 2019 and allowed it to go bankrupt the next year. Such steps should help lenders deal with a potential spike in bad loans as the property slump drags on.

But de-risking comes with a price.

Bert Hofman, former China director at the World Bank who now heads the National University of Singapore’s East Asian Institute, says the PBOC’s three red line rules to rein in developers’ debt and aggressive expansion in late 2020 has contributed to the rapid deceleration of the industry.

“The three red line policy intended to reduce the risks in the real estate sector,” said Hofman. “But the default of some of the property developers in its wake and the subsequent reluctance of people to invest in housing is causing a major economic slowdown and risks further defaults and even banking trouble.”

Hofman also argues that the clampdown on fin-tech and e-commerce platforms has made life much harder for small firms that depended on them to sell goods and get financing. “The authorities have underestimated how important fin-tech and e-commerce was for small and medium enterprises and credit to those enterprises,” he said.

While capital controls and greater flexibility in the yuan give Yi scope to diverge from the global tightening wave, China isn’t immune from it. Recent moves to open up much of the onshore market to foreign investors means maintaining a loose monetary policy increases the attractiveness of US assets like Treasuries relative to Chinese government bonds, spurring market outflows and harming sentiment.

No matter the international backdrop, Li Daokui, a former adviser to the PBOC and currently a professor at Tsinghua University in Beijing, says more stimulus will be needed if Covid and the restrictions to contain its spread continue to weigh on the economy. He sees scope to cut interest rates by another 30-50 basis points by June 2023.

“Right now, monetary policy should do everything possible to avoid the financing chain in the housing market from breaking,” he said.

Source: Bloomberg

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