The risks of se­lec­tive eas­ing

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

The Chi­nese govern­ment is fi­nally get­ting wor­ried about the econ­omy. Fol­low­ing a se­ries of in­spec­tion tours, Pre­mier Li Ke­qiang has clearly sig­nalled that he doesn’t want growth to slow much from the cur­rent rate. The State Coun­cil has asked the People’s Bank of China (PBOC) and var­i­ous min­istries to take sup­port­ive mea­sures. The cen­tral bank is com­ply­ing, reluc­tantly, but the risk is that its min­i­mal­ist moves both fail to sup­port growth and un­der­mine the cred­i­bil­ity of struc­tural re­forms.

The PBOC ap­pears to be do­ing as lit­tle as it thinks it can get away with. It has cut the re­quired re­serve ra­tio for ru­ral banks and for about two-thirds of small city commercial banks that can show they de­vote at least 30% of their loans to small and medium en­ter­prises. This move will in­ject a rel­a­tively mod­est RMB150-200 bln of fresh liq­uid­ity into the sys­tem. In ad­di­tion, there are re­ports that the PBOC has started a “re-lend­ing” scheme un­der which it lends di­rectly to a few banks on the con­di­tion that the funds are used for loans sup­port­ing so­cial hous­ing and agri­cul­tural in­vest­ment. But it has left in place the 20% RRR for the big­ger banks that ac­count for over 80% of lend­ing, and has sig­naled no cut in in­ter­est rates.

Why is the PBOC be­ing so se­lec­tive? Ba­si­cally, it fears that a broader eas­ing would just fat­ten the sec­tors that are caus­ing the econ­omy’s fun­da­men­tal prob­lems, such as property de­vel­op­ers, big state owned en­ter­prises, and lo­cal govern­ment fi­nanc­ing ve­hi­cles. The head of the PBOC sta­tis­tics depart­ment, Sheng Songcheng, wrote in Cai­jing mag­a­zine last week that there is very limited room for mon­e­tary eas­ing, as cor­po­rate lever­age in China is al­ready higher than in Ja­pan. In­stead, he ar­gued, the govern­ment should fo­cus on struc­tural re­forms to im­prove the be­hav­iour of bor­row­ers.

So the PBOC is try­ing to strike a com­pro­mise be­tween the pre­mier’s man­date to sup­port growth, and the longer-run im­per­a­tive to keep up the heat on the struc­tural re­form agenda. There are two risks to this ap­proach. First, sta­bil­is­ing growth may re­quire much more sup­port. The property mar­ket looks shaky-hous­ing prices fell in May for the first time in two yearsand we are al­most cer­tain to see weaker con­struc­tion ac­tiv­ity and real-es­tate in­vest­ment in the com­ing months. This in turn is putting pres­sure on lo­cal gov­ern­ments, which have seen their rev­enues from land sales and property trans­ac­tions dry up. So the PBOC may be forced into a months-long stut­ter-step of additional tar­geted mea­sures, un­der­min­ing the cred­i­bil­ity of the govern­ment’s com­mit­ment to re­form.

Sec­ond, the tech­nique of se­lec­tive eas­ing it­self goes against the cen­tral tenet of Xi Jin­ping’s re­form pro­gramme, which is to let the mar­ket play a more de­ci­sive role. By tar­geted RRR cuts and re-lend­ing, the cen­tral bank is ac­tively guid­ing banks’ credit de­ci­sions, and thereby re­duc­ing the mar­ket’s role in re­source al­lo­ca­tion. Some might ar­gue that the PBOC is sim­ply do­ing the same thing as the ECB, which last week an­nounced a four-year, EUR 400 bln “tar­geted LTRO” pro­gramme. But the con­text is very dif­fer­ent. In Europe, in­ter­est rates are al­ready neg­a­tive, and it is vir­tu­ally im­pos­si­ble to co­or­di­nate fis­cal poli­cies across the whole Eu­ro­zone. In prin­ci­ple, China still has the full ar­se­nal of con­ven­tional mon­e­tary and fis­cal pol­icy tools at its dis­posal.

The only thing that could bail out the cen­tral bank is a big re­bound in ex­ports, which grew at a smart 7% YoY in May and could ac­cel­er­ate fur­ther if US de­mand picks up in the sec­ond half of the year. If strong ex­ter­nal de­mand en­ables this year’s real GDP growth to come in at 7% (which we think is roughly the floor ac­cept­able to Pre­mier Li), all well and good. But if ex­ports are weak, then the govern­ment will be faced with a stark choice.

It could let growth dis­ap­point, which would be a good sig­nal for the com­mit­ment to re­form but po­ten­tially very dam­ag­ing for busi­ness con­fi­dence in the short run. Or the Pre­mier could or­der the PBOC to re-open the credit taps, in a re­vival of the old and dis­cred­ited strat­egy of boost­ing growth through in­ef­fi­cient in­vest­ment. Se­lec­tive eas­ing may be the least bad op­tion at the mo­ment, but it is no sil­ver bul­let. Other re­forms need to be pushed for­ward quickly enough so that China doesn’t find it­self caught in the over-in­vest­ment trap.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.