China can offset Fed move
Impact on the nation from US rate hike declining, due to PBOC’s autonomous monetary policy
Since the international monetary system is dominated by the dollar, the US Federal Reserve’s rate hike is bound to have a spillover effect on other economies and constrain the maneuvering space for their monetary policy to varying degrees.
Yet the impact on China of the Fed’s rate hike has been declining, due to the nation’s autonomous monetary policy.
Still, the People’s Bank of China needs to stabilize the macroeconomy through balanced monetary policy, especially since expanding monetary credit and reducing cost of capital are its two important intermediary goals.
According to Bank for International Settlements data, at the end of April, about 3.3 percentage points of China-US policy interest rate spread was in a relatively high range.
But the Fed’s decision to raise the interest rate by 50 basis points from June will narrow the policy interest rate spread between the two countries. This in turn will make it difficult for China to promote economic growth by cutting interest rates. Yet China could still boost the economy by taking measures such as cutting the reserve requirement ratio.
In terms of cross-border bond investment, the yield gap between China and the US has narrowed rapidly, even leading to inversion. The yield on the 10-year US Treasury bond was only 1.52 percent at the end of last year.
But on Feb 10 this year, the yield on the 10-year US Treasury bond exceeded 2 percent, reaching a high of 3.12 percent on May 6 and then dropping to 2.84 percent on May 12.
On the other hand, the yield on China’s 10-year treasury bond has been quite stable, basically staying in the range of 2.5-3.2 percent since 2020. On May 12, for example, the yield on China’s 10-year treasury bond was 2.81 percent, meaning the interest rate spread between the US and China has “inverted”.
As for long-term capital flows, China has been the leading major economy in terms of growth because it has further opened up its economy despite the COVID-19 pandemic.
China also remains a top overseas direct investment destination, attracting $144.37 billion in 2020 and $173.48 billion in 2021.
Ministry of Commerce data show that in the first quarter of 2022, China’s actual use of foreign capital was 379.87 billion yuan ($55.9 billion), up 25.6 percent year-on-year.
From the perspective of short-term capital flow, China Central Depository & Clearing Co statistics show the value of bonds held by foreign institutional investors at the end of March 2022 was about 3.57 trillion yuan, down 110 billion yuan year-on-year.
From the end of 2021 to the end of March 2022, overseas institutions reduced their holdings of government bonds by 21.56 billion yuan and policy bank bonds by 79.59 billion yuan.
The proportion of bonds held by overseas institutions in the inter-bank bond market fell from 4.41 percent at the end of 2021 to 4.16 percent at the end of March.
Given that the interest rate spread between the US and China has significantly narrowed, even “inverted”, it is natural for foreign institutions to somewhat reduce their holdings of Chinese bonds.
As far as capital outflow from the stock market is concerned, according to WIND Information Co data, by the end of 2021, foreign capital held about 2.96 trillion yuan, or 3.95 percent, of A shares’ circulating market value, and as of May 12, foreign capital held 2.31 trillion yuan, or 3.71 percent, of A shares’ circulating market value. This suggests China’s cross-border capital flow has remained basically stable, with short-term increase in capital outflow to some extent. With regard to the yuan’s exchange rate, the US dollar index has strengthened due to the Fed’s interest rate hike and relatively loose monetary policy of the economies in the US dollar index.
From Jan 1 to May 12, the US dollar index increased by about 9.2 percent, and the yuan depreciated by about 6.8 percent, although the depreciation of the yuan against the dollar is lower than that of the euro, yen and the pound.
If the Fed hikes rates again, the interest rate spread between the US and China will further narrow, increasing the risk of short-term capital outflow. Albeit, in the medium and long term, China’s economic fundamentals remain positive.
So it is necessary to implement macro-prudential management during the Fed’s interest rate hike window, avoid excessive short-term fluctuations in the financial market, and prevent fears of the yuan depreciating rapidly.
Also, since the pandemic has put downward pressure on the economy and lowered market expectations, it is necessary to contain it as soon as possible, and resume normal economic activity, stabilize growth and increase employment.
Stable job and financial markets and a secure exchange rate combined with steady growth will offset to a large extent the spillover effects of the Fed’s interest rate hikes and prevent financial risks caused by excessive fluctuations in asset prices.