PBOC Uses Hidden Hand as China Seeks to Stem Slowdown: Economy

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PBOC Governor Zhou Xiaochuan
In a closed-door speech made at Tsinghua University in May, Zhou Xiaochuan, governor of the People's Bank of China, said forward guidance adopted by the Fed when it was running out of policy options may not serve China, which still has room to send clear messages via policy moves. Photographer: Brent Lewin/Bloomberg

The People’s Bank of China is turning to a hidden hand as it seeks to stimulate the world’s second-largest economy without worsening debt risks.

Contrary to the Federal Reserve’s forward guidance, the Bank of England’s increased transparency and a Group of 20 Nations vow to clearly communicate policies, China has added liquidity by stealth at least four times in the past four months. One proxy it has been using is China Development Bank Corp., the nation’s biggest policy lender.

Balancing the need to buoy an economy set for its slowest full-year expansion since 1990 and efforts to contain a debt pile that’s almost doubled in six years, China’s leaders have sought a targeted monetary path that’s deviating from advanced economy peers. Problem is, by keeping in the shadows, speculators have jumped in, pushing the stock market up over 20 percent since the PBOC’s benchmark interest rate cut on Nov. 21 in anticipation of more monetary easing.

“It lacks both transparency and effectiveness,” said Ding Shuang, senior China economist at Citigroup Inc. in Hong Kong, who used to work at the PBOC. “On this year’s policies, I can say I have no clue of their reasoning.”

On transparency, Governor Zhou Xiaochuan’s past comments suggest he’s less wedded to the global push for clearer policy signaling and prefers to let actions speak for themselves. In a closed-door speech made at Tsinghua University in May, Zhou said forward guidance adopted by the Fed when it was running out of policy options may not serve China, which still has room to send clear messages via policy moves.

As for effectiveness, one criticism of unannounced liquidity injections is that they lack “signaling impact” compared with benchmark rate cuts or lowering bank’s reserve requirement ratios, analysts at Morgan Stanley led by chief China economist Helen Qiao wrote in a research note this month.

Stealth Injections

The PBOC will lower the benchmark one-year lending rate by 25 basis points to 5.35 percent in the first quarter and by another 15 basis points by the end of June, according to economists surveyed by Bloomberg from Dec. 18-23. The central bank may cut banks’ required reserve ratio by a total of 1 percentage point in the first half, the survey found.

The PBOC rolled over at least part of a 500 billion yuan ($80 billion) three-month lending facility to the largest Chinese lenders last week, days after it injected 400 billion yuan via CDB, according to people familiar with the steps. Neither move, nor an offer of short-term liquidity to banks, has been officially announced.

Targeted Policy

These steps followed a 1 trillion yuan loan to the CDB to bolster social housing reported first in the middle of the year yet only confirmed in a government statement in December. Injections of 769.5 billion yuan in September and October were announced almost two months later in a quarterly report.

The PBOC didn’t reply to faxed questions seeking comments, and phone calls to CDB went unanswered.

“The financial system in China does not do a good job of transmitting policy signals through the rest of the economy,” said Mark Williams, Chief Asia Economist at Capital Economics Ltd. The PBOC is leaning on CDB to “introduce the kind of monetary easing that they are looking for,” he said.

He expects more such stealth operations in coming months.

The PBOC has become busier as the year progressed: on top of the liquidity injections, it lowered deposit ratios and cut re-loan rates for some designated banks. As the economy continued to lose momentum, it reduced benchmark lending and deposit rates last month, taking economists by surprise with a 6:30 p.m. Friday evening statement.

Real Power

“It’s obvious that the central bank didn’t want to cut the interest rate -- other ministries were calling for a cut,” said Dong Tao, chief regional economist for Asia excluding Japan at Credit Suisse Group AG in Hong Kong. “The central bank can’t solely decide China’s interest rate moves, and the real decision making power lies at the State Council.”

The PBOC follows orders from the cabinet and shoulders responsibility for sustaining the economy and controlling inflation, while pushing policies such as interest-rate liberalization and currency internationalization.

“Initiating monetary injections indirectly through the CDB helps the PBOC maintain its focus on financial sector reforms and avoid sullying its own hands through direct monetary stimulus or by directly supporting specific sectors of the economy,” Eswar Prasad, a professor of trade policy at Cornell University in Ithaca, New York, and senior fellow at the Brookings Institution in Washington, wrote in an email.

Prasad, who used to work for the International Monetary Fund, said that PBOC is not the only central bank using state-owned banks as proxies. Indian state banks were required to pump up their lending sharply during the global financial crisis, Prasad said.

Policy Lender

Brazil uses Banco Nacional de Desenvolvimento Economico e Social, known as BNDES, to provide subsidized loans to industries. This month, Brazil’s government authorized a transfer of 30 billion reais ($11 billion) from the Treasury to the state bank to finance the purchase of equipment and machinery.

CDB is the largest of three policy lenders China set up in 1994 to take over government-directed spending functions. It is tasked with “serving China’s medium, long-term economic development strategies,” according to its website.

Headed by the former PBOC executive deputy governor Chen Yuan from 1998 to 2013, CDB played a key role in designing the stimulus framework through the global financial crisis. It pumped credit to local governments to ramp up infrastructure spending and sold trillions of yuan worth of bonds in the interbank market. CDB is the second-largest bond issuer in China next to the Ministry of Finance with nearly 6 trillion yuan in outstanding bonds as the end of 2013.

Financially Stronger

“By using China Development Bank, the PBOC can accurately direct liquidity into the real economy,” said Xu Gao, Chief economist at Everbright Securities Co. in Beijing. “More capital makes the policy bank financially stronger and enables it to offer loans to local governments so that approved infrastructure projects can start construction.”

Such advantages have seen the PBOC embrace its targeted approach while vowing it will keep policy prudent.

“By sticking to the ‘prudent monetary policy’, it is difficult for the public to understand the new tools,” Morgan Stanley analysts led by Qiao wrote. “With a wider range of instruments and a narrower transmission mechanism, the PBOC stands out from the rest of major central banks globally.”

— With assistance by Xiaoqing Pi, and Xin Zhou

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