In China, Focus of Monetary Easing Turns to Surgical Strikes

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People's Bank of China Governor Zhou Xiaochuan
The benchmark lending rate stands above 5 percent, giving People's Bank of China Governor Zhou Xiaochuan the kind of firepower Janet Yellen may never see in her tenure as Fed chair. Photographer: Tomohiro Ohsumi/Bloomberg

After years of emergency policymaking by counterparts in the U.S., Japan and Europe, it’s the People’s Bank of China’s turn to innovate.

Unlike the Federal Reserve, Bank of Japan and European Central Bank, which unleashed unprecedented quantitative easing through central government bond purchases to revive credit growth, the PBOC is pursuing a more measured approach.

While it has taken some broad easing steps, including two interest-rate cuts, the central bank still requires commercial banks to park almost one in five yuan of deposits at the PBOC. The benchmark lending rate stands above 5 percent, giving Governor Zhou Xiaochuan the kind of firepower Janet Yellen may never see in her tenure as Fed chair.

Instead of turning the liquidity sprinkler on full-throttle for the whole garden, the PBOC instead is aiming its hose at specific parts of the yard. The latest innovations include plans to bolster the market for local-government bonds and the recapitalization of policy banks so they can boost lending to government-favored projects.

High Wire Act

The strategy is all part of a high-wire act by President Xi Jinping and Premier Li Keqiang to avoid the type of credit crunch and growth slump that afflicted the U.S. and Europe while still reducing debt in an economy that over-relied on investment to drive growth. As China continues to slow, economists are betting more conventional easing will be needed.

“The PBOC is again looking for ways to channel financing to preferred destinations while containing overall financing,” said Louis Kuijs, Royal Bank of Scotland Group Plc’s chief greater China economist in Hong Kong, who previously worked at the World Bank in Beijing. “While it seems catchy to say that China is now joining the bandwagon with its own form of QE, in my view the differences in circumstances, nature and objectives are too large to credibly make that case.”

Policy makers have sought to bolster credit for small and medium-sized enterprises, and borrowers supporting the goals of the Communist leadership, such as the “One Belt, One Road” initiative developing infrastructure along China’s old Silk Road trade routes. Borrowers in heavy-polluting industries and speculative real estate are in areas of the economy Xi and Li are seeking to deleverage.

Biggest Challenge

“The biggest challenge facing the PBOC is whether it can substantially lower firms’ funding costs without directing credit to overcapacity sectors and unviable firms, leading to another credit boom,” said Liu Li-Gang, chief Greater China economist in Hong Kong at Australia & New Zealand Banking Group Ltd. “It will have to strike a balance between outright easing and targeted easing.”

In Japan, the U.S. and Europe, central bankers turned to large-scale asset purchases as they ran out of interest-rate cut ammunition. In the depths of the credit crisis, the Fed also created a series of programs designed to prevent a complete collapse of specific parts of the financial system, including housing finance, commercial paper and money-market funds.

BOJ officials earlier this decade tried to address a stagnant economy in part through a venture-capital style fund making credit available for borrowers in innovative, growth industries.

Usable Tools

For China, “there are many usable tools” open to the PBOC, Ma Jun, chief economist at the central bank’s research bureau, said in a statement based off his interview with China Business News. “There will be specific arrangements for local-government debt swaps, and these arrangements will not lead to market liquidity tightening.”

Along with reserve-requirement ratios for banks’ deposits, the setting of benchmark lending rates and money-market operations, the PBOC’s toolkit now includes more surgical armaments. One of them, the Pledged Supplementary Lending program, was used last year to channel funds to building low-cost housing, via the state-owned lender China Development Bank.

Through what was reported by local media to be three-year funding, the PBOC offered credit at terms about 1 percentage point below market rates. The central bank also maintains re-lending facilities, where it accepts collateral from banks in return for fresh money that can be used for new borrowing.

Growth Target

Officials are now considering expanding the PSL to help local-government debt purchases.

Helping local authorities will be critical to preventing a deeper economic slump, after gross domestic product rose by the least since 1990 last year. China wants to make sure that local governments can sell bonds, without resorting to securing off-balance sheet loans in the shadow banking market.

“If local governments can’t raise low-cost funds, some projects may lack funding support and even lead to defaults, and this in turn will hurt China’s growth target,” said Li Wei, the China and Asia economist for Commonwealth Bank of Australia in Sydney. Quantitative easing by buying bonds “is a kind of emergency measure and a last resort, and China has not reached that point to opt for QE.”

With capital flowing out of China, an exchange rate appreciating against some of the nation’s top trade partners and a sinking inflation rate pushing up the real cost of borrowing, there may be little choice but to turn on the garden sprinkler. The government set a growth target of about 7 percent this year. The International Monetary Fund forecasts less than 7 percent.

Balancing Act

“The belief many hold that China is growing below its potential will prompt the PBOC to provide more easing to underpin the economy,” said Angela Beibei Bao, an analyst with Rhodium Group in New York.

Bolstering calls for additional policy easing: a measure of the broad money supply at the end of March was the second- weakest since at least 1996, after the level reached in January, according to data compiled by Bloomberg. An analysis by Oxford Economics Ltd. found that in the first quarter of 2015, broad money supply grew at its weakest in 28 years.

“For most of the past year the PBOC has been behind the curve,” said Alessandro Theiss, an economist at Oxford Economics in Oxford, U.K. “But the Chinese authorities also remain committed to weaning the economy off its dependency on credit -- implying that monetary conditions will have to remain relatively tight compared to their long-term average. This will require a careful balancing act.”

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