Boosting bank lending is not the answer

Rather, China needs to try and de-escalate a costly long drawn-out trade war with the US

Isuspect that long-time watchers of China’s reform efforts may not be that enthusiastic about its central bank’s decision to cut the required reserve ratios for banks.

Although understandable as a short-term response to a more challenging growth environment, it risks being another attempt to crank up an old economic model whose effectiveness has declined and whose unfavourable side effects could increase. If this tactical approach were to sideline deeper reforms, including the critical reorientation of the country’s growth engines, China may find it harder to avoid the middleincome trap that has frustrated the development breakout of other emerging economies.

The PBOC’s immediate goal is to stop what has been a steady decline in the growth of bank lending, thereby boosting the availability of credit for business and commercial investment. The cut in banks’ required reserves is an understandable short-term response.

But it comes with three longer-term risks: First, it goes against the much-needed transition from credit- to incomedriven domestic growth. Second, it may conflict with efforts to strengthen the financial system. Third, it could end up subsidising inefficient activities, while taking off the pressure on some state-owned enterprises.

Due to the confrontational approach of the Trump administration, China is having to manage through a sudden disruption in its external trade regime that has proven both hard to understand and predict for the authorities in Beijing. And the dislocations could well go deeper.

The best approach for China is to look for ways to defuse quickly the growing trade tensions with the US, while continuing to re-orient the economy in favour of domestic drivers of growth. This is neither an easy nor a particularly attractive option especially given the difficulties of establishing trust, as well as the need to come up with measures that are subject to credible verification. There is also the issue of saving face.

But the alternative would place at risk a bigger issue — that is, the continuation of the country’s impressive development process.