Don't Expect China Stimulus to Have Same Effect as the Fed's

PBOC Governor Zhou Xiaochuan
Zhou Xiaochuan, governor of the People's Bank of China. Photographer: Tomohiro Ohsumi/Bloomberg

When it comes to spiking the global punch bowl, Zhou Xiaochuan doesn’t come close to central bankers in the U.S. or Europe.

After central bank stimulus from the Federal Reserve and European Central Bank had a ripple effect in foreign financial markets, economists from UBS Group AG are advising investors not to expect a similar lift as Zhou’s People’s Bank of China cuts interest rates and encourages banks to lend.

“The transmission mechanisms are completely different,” Bhanu Baweja, UBS’s London-based head of emerging market cross asset strategy, said in a telephone interview.

For one thing, China’s stimulus has so far proved weaker than that of the Fed or ECB, with UBS noting money growth is still not rising aggressively and interest rates adjusted for inflation only falling modestly even after three reductions in six months.

The stimulus which has been injected is also unlikely to reduce the cost of risk as much as similar actions did elsewhere, says UBS. When the Fed cut its benchmark to about zero, for example, market borrowing costs also fell, helping the many global companies that borrow in dollars. By comparison, few international firms raise funds in the yuan, so the PBOC won’t lower the cost of equity as much worldwide.

“China’s easing does nothing for the cost of equity for firms in Brazil, South Africa or Indonesia,” said Baweja.

Smaller Flows

There are also still limits on how much cheaper Chinese money will flow into global assets in the hunt for better returns, even if the country’s financial markets are more liberalized than they once were. While outward portfolio investment totaled more than $400 billion annually from both the U.S. and euro-area in the last two years, the total amount for China was just $90 billion as of April, reflecting how hard it is for financial institutions to make offshore investments.

The yuan is also unlikely to replicate the declines witnessed in the dollar and euro when their central banks were acting, which had a knock on effect on capital flows and asset values. Keen to make its currency more of a global player, China won’t want it to depreciate much and any drop it does allow risks being matched by neighboring nations. On the positive side, by keeping the yuan stable, China is sparing the world what would be another major deflationary pressure.

That leaves the hope that the PBOC could help boost global corporate earnings by stoking demand. The problem here is the Chinese authorities are trying to rebalance the economy away from construction, whose previous rise had a spillover elsewhere through higher commodities, according to UBS.

Economic Heft

While the PBOC’s policies may lack the global punch of the Fed or ECB, China’s influence on the world economy is ever more important. At Oxford Economics Ltd., economist Adam Slater said in a report this month that a slowing China could still pull down global bond yields via falling commodity prices, slowing trade and the fact that businesses rely on the country for an increasing share of profits.

“The sheer weight of China in the global economy means that big shifts in its economic performances can have profound impacts on global asset prices -- notwithstanding China’s relatively weak direct linkages to world financial markets,” said Slater.

As those linkages strengthen, the PBOC will become more influential internationally. Authorities are bringing down barriers to its capital markets and the yuan is set to rise in prominence, with or without reserve status from the IMF.

If the economy can be pivoted toward consumption and demand for imports, its sway will be all the greater. At the moment, China’s consumer market is 30 percent the size of the U.S.’s, up from 8 percent in 2000, according to Capital Economics Ltd.

For now though UBS’s recommendation is that investors buy Chinese assets “against those of shops that sell to China.”

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