China may move toward easy monetary policy, but must tread carefully

People walk in front of the headquarters of the People’s Bank of China (PBOC), the central bank, in Beijing, China, September 28, 2018.

Jason Lee | Reuters

BEIJING – China’s central bank is preparing to move cautiously toward easing monetary policy, even as the United States heads to tighten monetary policy.

In the opposite direction, the People’s Bank of China will need to strike a delicate balancing act, as policymakers keep a close eye on inflation and the rising cost of US dollar-denominated debt.

Analysts say monetary policy easing may not come in overt moves such as reducing the amount of liquidity that banks must hold as reserves, or the monetary review ratio – one of the many policy tools the central bank maintains. Instead, China is likely to seek targeted steps.

Here’s why.

First, the dispute with the United States could have several consequences for the market.

Jefferies analysts noted in a note on Monday that several Chinese companies, especially property developers, have amassed large amounts of US dollar-denominated debt. Paying off this will become more difficult when the US dollar rises or US yields begin to rise on the back of the planned reduction by the Federal Reserve in asset purchases.

The Fed released last week’s meeting minutes which showed the US central bank is on track to tighten, likely as soon as next month. The move comes at a time when US policy makers are concerned about persistent inflation.

China faces the same challenge. The producer price index, a measure of production costs for factories, rose by a record 10.7% in September from a year ago.

“Continuing inflationary pressure limits the potential scope of monetary policy easing,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

But it is becoming clearer than ever to many economists that China will need to ease.

[China’s] The slowdown in growth has reached levels that policy makers can no longer ignore and we expect to see an incremental regression across three pillars – monetary, fiscal and regulatory.

BlackRock Investment Institute

Third-quarter GDP data released on Monday showed that China’s economy slowed more than expected. The lack of power restricted the plant’s production. Stricter legislation on debt in the real estate industry has cut off a sector that contributes to a quarter of China’s gross domestic product.

“The slowdown in growth has reached levels that policymakers can no longer ignore and we expect to see a gradual decline across three pillars – monetary, fiscal and regulatory,” BlackRock Investment Institute analysts said in a note on Monday.

Earlier this year, Beijing was more focused on tackling social issues, such as the rising costs of raising children in a country whose population is rapidly aging. The regulatory campaign over the summer included, surprisingly, that after-school tutoring firms had to significantly reduce their hours.

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Sun Guofeng, head of the monetary policy department at the People’s Bank of China, confirmed to reporters last Friday how the central bank’s monetary policy has remained “prudent”. He said producer prices are likely to remain high but moderate by the end of the year.

Sun also said the central bank is aware of the Fed’s statement. He did not discuss whether US actions would affect China, and repeatedly said that China has many monetary policy tools.

Targeted monetary policy adjustments

Analysts have long pointed out that China’s unique economic structure relies more on a set of monetary policy tools, rather than a single interest rate.

“Monetary policy will be eased appropriately,” Zong Liang, chief researcher at the Bank of China said Tuesday in Mandarin, according to a CNBC translation.

While keeping overall monetary policy at a “normal” level, he said the central bank could ease policy for certain sectors. For example, the People’s Bank of China (PBOC) can help companies that are struggling to afford the high cost of raw materials. Zhong also expects that support for stable economic growth will include strengthening infrastructure.

He said China wanted to avoid a situation where policy support would raise costs for ordinary consumers as well as for businesses.

While producer prices rose 10.7% in September from a year ago, the CPI remained subdued and rose only 0.7% year over year.

When it comes to monetary policy changes, many economists have lowered their expectations that China will cut its reserve requirement ratio (RRR) by the end of this year.

“We believe the weak third-quarter data will push Beijing to back away further from its growth-restricting policies,” said Aidan Yao, chief emerging economist for Asia, at AXA Investment Managers.

We are likely to see a broader and prolonged slowdown in the real estate sector [the] The biggest negative risk we have to watch.

Francoise Huang

Chief Economist, Euler Hermes

He said the possibility of a broad-based RRR cut had receded in the wake of the People’s Bank of China’s recent comments, but that “a targeted move is still possible if growth falters further”.

On the financial side, Yao expects local governments to release about 1.3 trillion yuan ($203.3 billion) in cash from private bond sales in the next two months, which should “provide solid support” for infrastructure investment.

Letting the real estate market shake

However, Yao noted that Beijing’s tight control over the traditional channels of monetary policy implementation – including the housing market – will limit the impact of the overall policy easing stimulus.

The biggest obstacle to China’s growth remains the real estate sector. Beijing increased its efforts last year to reduce the industry’s reliance on debt for growth, which led to lower real estate investment and new home sales in September.

“It is likely to see a broader and prolonged slowdown in the real estate sector [the] “The biggest downside risk we have to watch,” said Françoise Huang, chief economist at Euler Hermes, a subsidiary of financial services firm Allianz.

She said policy makers are trying to “phase out the most indebted, illiquid or insolvent companies, while at the same time limiting contagion to other sectors.”

Huang does not expect Beijing to allow the economy to slow down so much that China can barely meet its 6% GDP growth target this year. Most economists expect growth of about 8% this year.

But with policymakers this year focused on tackling long-term problems in the economy, Beijing may not be inclined to stimulate growth as much as it once was, she said. “Their tolerance for slowdown and their tolerance for risk may be higher than in the past.”

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