Goldman Forecaster Urges China to Tighten Monetary PolicyBy
Real lending rate for companies has turned negative again
Low real rates fuel borrowing, adding to financial risks
China should tighten monetary policy as signs of overheating emerge amid quickening inflation, according to the top-ranked forecaster for the nation’s economy.
With policy makers torn between reining in price gains and stabilizing growth, corporate lending has become too cheap, said Song Yu, chief China economist at Beijing Gao Hua Securities Co. The real interest rate for companies -- the lending rate minus producer price increases -- has turned negative for the first time since 2011 as the People’s Bank of China kept its benchmark lending rate at a record low and the economy snapped out of a deflationary funk.
“Economic growth is trending down gradually while inflation is trending up,” said Song, whose firm is Goldman Sachs Group Inc.’s joint-venture partner in the mainland. “This makes it hard for policy makers to be decisive in moving in one direction or the other.”
Song, 38, who holds a master’s degree from Oxford University and used to work at the Federal Reserve and European Parliament, was the top ranked forecaster for Chinese economic indicators in the fourth quarter of last year, according to data compiled by Bloomberg. That continues a winning stretch dating back to late 2012. The rankings measure the accuracy of analysts’ estimates for key data releases.
China’s policy makers are in a bind: While faster inflation and U.S. rate increases argue for monetary tightening, steady economic growth is also key as leaders brace for potential trade tensions amid Donald Trump’s protectionist threats and a reshuffle of high-level Communist Party officials this year. Instead of raising benchmark borrowing costs, the PBOC has pushed up money-market rates since August, sparking a bond selloff.
Yet to Song, the tightening has been too little, too late -- and too ambiguous.
The PBOC’s mixed signals have caused money-market rates to go from low and steady to high and volatile, which can lead to “misunderstandings about policy intention,” said Song. With monetary policy constrained by an inflexible exchange rate, China is also becoming more reliant on administrative measures such as capital controls or lending guidance, rather than market-based tools, he said.
“This is a big challenge from a reform perspective,” he said.
In another illustration of the PBOC’s balancing act, it raised the rates on its Medium-term Lending Facility on Tuesday, which injected 245.5 billion yuan ($36 billion) into the financial system. Swap rates and bond yields jumped on the news.
China’s economy is faring better than even Song had anticipated. Amid a rocky start to 2016 in currency and stock markets, he said at the time there was no need to panic, forecasting full-year growth of 6.4 percent. Fiscal support and buoyant consumption helped fuel a 6.7 percent expansion, data last week showed.
Economic stabilization is coming at a cost, with the efficiency of credit lackluster and overall debt rising to 264 percent of GDP, according to Bloomberg Intelligence estimates. Fitch Ratings warned Monday that China’s continued use of policies prioritizing short-term growth targets is becoming a "more significant" risk to medium-term economic stability. Faster growth in the fourth quarter reflected stimulus measures rather than a sustainable pick-up, the agency said in a report.
Song’s trick for foreseeing China’s economic trajectory boils down to this: “Over the past five years there had been some fairly stable cyclical patterns within the year, and these patterns basically revolve around changes in government policy,” he said.
Yet recently, that pattern seems to have broken down as the ostensible policy tightening didn’t do much to curb demand, he said. Inflation is picking up partly because as working-age population growth slows, supply can’t catch up with demand, he said.
“There’s only one solution: boost potential growth,” he said. “In order to do that you have to undergo reforms, which include further opening up and market liberalization. But implementation needs to be strong. China’s issue is sometimes they say they ‘have to’ do this, but if they don’t lay down any concrete actions, it can be delayed for a long time, and during this process, potential growth slows.”
— With assistance by Xiaoqing Pi
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