PBC needs powerful policy tools
On October 7, the last day of the week-long National Day holidays, the People’s Bank of China (PBC), the central bank, said it would cut the reserve requirement ratio (RRR) for some lenders by 100 basis points, effective October 15.
The central bank’s move aims to enhance financial support to the real economy and optimize the nation’s liquidity structure. The move is expected to free up 750 billion yuan ($109 billion) of capital. The PBC also said it would maintain a prudent and neutral monetary policy.
The RRR cut is a policy adjustment made after the US Federal Reserve’s interest rate hike triggered global liquidity tightening and financial market turmoil. Recent remarks by Fed officials basically confirmed expectations for further rate increases, which without doubt offered a boost to the US dollar. The US Dollar Index even rallied above the 96 mark on October 4.
Obviously, the Fed made the rate hike decision without a care for tight liquidity in global markets or economic conditions in emerging-market countries and Europe. The stronger US dollar again led to considerable depreciations of emerging-market currencies.
In the meantime, US bond and stock markets also fell as a result of the Fed’s rate hike. Last week, yields of 10- and 30-year Treasury bonds moved to multiyear highs of 3.25 percent and 3.42 percent, respectively; while the Standard & Poor’s 500 and NASDAQ lost 0.98 percent and 3.2 percent week-on-week. Stocks in Europe and emerging markets also suffered major setbacks.
Against this background, the RRR cut is meant to inject liquidity to hedge against the global liquidity tightening caused by the US rate hike. China’s macroeconomic policy is shifting to one of stabilizing growth on the whole. The PBC said that there won’t be excessive liquidity, but it also said that maintaining ample liquidity is both a prerequisite for steady economic growth and a guarantee of continuous structural adjustment.
Generally speaking, China’s RRR cut and the US’ interest rate hike are two completely different monetary policies, which highlight the differences between the two countries’ economic conditions. The US economy is in good condition, with global market turmoil conducive to its interests.
China, however, faces the arduous tasks of structural adjustment and poverty alleviation, and it must also prevent economic growth from losing steam. China’s economic growth and monetary policy are subject to external and internal factors.
Externally, the trade friction provoked by the US unilaterally has brought great uncertainty to the world economy; internally, the Chinese economy is facing the risk of losing momentum. There has been increasing pressure from these two factors.
Yet, China’s monetary policy adjustment should be mainly based on its own economic fundamentals instead of external factors. To keep economic growth from stalling, the central bank should take some easing measures under the general tone of a neutral monetary policy. Specifically, it should be flexible in using policy tools to inject adequate liquidity into the market.
Meanwhile, depending on the economic situation, it should prepare more powerful monetary and fiscal policy tools, possibly including a large-scale stimulus package. Compared with the RRR level of 9.5 percent in 2007, there is still room for further reduction in the current ratios of 14.5 percent for large financial institutions and 12.5 percent for small and mediumsized lenders.
The exchange rate is also part of China’s monetary policy adjustment. Given continuing trade friction between China and the US, the yuan will be under pressure in general. Further, factors like China’s narrowing current account surplus, lack of synchronization with US interest rate changes and concerns over domestic GDP growth will affect market expectations of the yuan’s value.
According to our estimates, the bottom line of the yuan against the US dollar will be about 7.0 to 7.5. But still it should be noted that a moderate depreciation of the yuan will not harm China’s focus on growth stabilization.
Overall, under the influence of the Fed’s rate hike decisions, which can be characterized by “America First,” volatility will persist in global markets. Despite such external factors, China should still set its monetary policy based on its economic fundamentals. With the economy facing intensifying downward pressure, the PBC is stepping up its easing policies to prevent economic growth from losing steam. It can be said that China’s macroeconomic policy is shifting overall to stabilizing growth.
With the economy facing intensifying downward pressure, the PBC is stepping up its easing policies to prevent economic growth from losing steam. It can be said that China’s macroeconomic policy is shifting overall to stabilizing growth.