This Is What China's Version of Quantitative Easing Looks Like

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Quantitative Easing Chinese Style...

China’s leaders are increasingly relying on the central bank to help implement government programs aimed at shoring up growth, in an adaptation of the quantitative easing policies executed by counterparts abroad.

Rather than bankroll projects directly, the People’s Bank of China is pumping funds into state lenders known as policy banks to finance government-backed programs. Instead of buying shares to prop up a faltering stock market, it’s aiding a government fund that’s seeking to stabilize prices. And instead of purchasing municipal bonds in the market, it’s accepting such notes as collateral and encouraging banks to buy the debt.

QE -- a monetary policy tool first deployed in modern times by Japan a decade and a half ago and since adopted by the U.S. and Europe -- is being echoed in China as Premier Li Keqiang seeks to cushion a slowdown without full-blooded monetary easing that would risk spurring yet another debt surge. While the official line is a firm “no” to Federal Reserve-style QE, the PBOC is using its balance sheet as a backstop rather than a checkbook in efforts to target stimulus toward the real economy.

“It’s Chinese-style quantitative easing,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. “But it’s not a direct central bank asset-purchase plan. China’s easing is indirect and more subtle compared with the U.S. or Japan.”

Exports, Inflation

Weekend data underscored the need for policy support. Producer price deflation deepened last month while consumer inflation remains about half the central bank’s target of 3 percent for this year. Exports declined more than economists expected in July, hobbled by a strong yuan and lower demand from the European Union.

China’s stocks surged the most in a month, with the Shanghai Composite Index gaining 4.9 percent.

The local government debt swap and recapitalization of policy lenders can help to address “clogged liquidity flows” to channel funds from the interbank system to economic activity on the ground, Macquarie Capital Securities Ltd. economists Larry Hu and Jerry Peng wrote in a note.

While policy lenders can’t replace a properly functioning financial market, the moves can “help fund infrastructure investment to support growth” over the next three to six months to help drive “a U-shaped recovery,” they added.

Stimulus Program

While there’s been no public unveiling of the strategy, China’s leaders are putting in place plans for the central bank to finance, indirectly, a fiscal stimulus program to put a floor under the nation’s slowdown. China will sell “special” financial bonds worth trillions of yuan to fund construction projects, and the PBOC will provide funds to state banks to buy the bonds, people familiar with the matter said this month.

China Development Bank Corp. and the Agricultural Development Bank of China -- known as policy banks because they carry out government objectives -- will issue bonds, people told Bloomberg earlier. The Postal Savings Bank of China will buy the debt, aided by liquidity from the central bank, according to one of the people.

It’s unclear whether by taking on bonds as collateral and delivering cash in return the PBOC’s official balance sheet will expand. In the U.S., the euro region and Japan, central banks have bought securities outright in secondary markets, making the quantitative easing transparent on their books.

Indirect Financing

By contrast, China’s current leaders, who took power in 2012, are opting for indirect financing -- a strategy that also prevents the central government’s debt burden from rising. A record credit expansion unleashed in 2008 during the global crisis is seen as having left the economy with excessive borrowing that’s now being restructured.

A lot of the credit growth unleashed ended up being spent on already existing assets, meaning it didn’t directly add to gross domestic product. After wrestling with that problem since about 2012, the central bank is stepping up ways to target credit so it’s steered toward newly produced goods and services, said Simon Cox, Asia-Pacific investment strategist at BNY Mellon Investment Management in Hong Kong.

“China is trying to channel the lending towards something that will have more stimulative oomph,” Cox said. “If that happens to be a public good that is in short supply, then that’s great, but first and foremost, let’s get it into the real economy.”

Policy Options

The PBOC still has more options that the Fed or Bank of Japan, which adopted unconventional easing when interest rates were close to zero. China’s one-year benchmark lending rate is

4.85 percent, and the required reserve ratio for the biggest banks remains at 18.5 percent, among the world’s highest even after a series of reductions.

In its second quarter monetary policy report published Friday, the PBOC reiterated it would stick to a “prudent” policy stance and use “various monetary policy tools” to manage liquidity and credit.

“China is not in a crisis mode, and it’s not necessary for the central bank to intervene too much,” said Li Wei, China economist for Commonwealth Bank of Australia in Sydney. “By definition, China has not started QE as the PBOC’s balance sheet isn’t expanding.”

China’s government under Li has repeatedly said it wouldn’t opt for a big stimulus plan and would keep a “prudent” monetary policy stance. Still, Li is seeking to shore up growth amid fresh signs the economy is lagging the official target of about 7 percent for this year.

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“It’s not an all-out QE as the Fed’s was, but there are increasing signs of a QE program,” said Chen Xingdong, chief China economist and head of macro-economics research at BNP Paribas SA in Beijing. Chen said the PBOC was now opening the door to borrowers, but hasn’t reached the stage of “forcefully flooding the market with money.”

— With assistance by Xin Zhou

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