China Holds Firm to $5 Trillion Anchor as Fed, ECB Seek Exit

  • PBOC’s assets contracted 3.1% from January-end to March-end
  • Asset holdings reduction won’t continue, economists say

PBOC's Balance Sheet Stabilizes

Investors who fret about when and how global central banks will run down their crisis-era balance sheets can be relaxed about the biggest of them all -- China’s.

Whereas the Federal Reserve’s $4.5 trillion asset pile is set to be shrunk and the European Central Bank’s should stop growing by the end of this year as the outlook brightens, China’s $5 trillion hoard is here to stay for the time being -- and could even still expand, according to the majority of respondents in a Bloomberg survey of People’s Bank of China watchers.

The PBOC balance sheet is a fundamentally different beast from its global peers -- run up through years of capital inflows and trade surpluses rather than hoovering up government bonds -- but it still matters for the global economy. Changes in the amount of base money in the world’s largest trading nation are having a bigger impact than ever, making the variable key for stability in a year when political transition in Beijing is in the cards.

"China is more than a couple of years away from balance-sheet contraction," said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong, pointing out that the growth in the broad money supply is still behind the government’s target.

The balance sheet has broadly leveled off, and contracted in the first quarter of this year, though that was mostly through seasonal factors related to liquidity operations around the Lunar New Year, when the demand for cash surges. Now, with the Fed set to raise rates this year, the PBOC is still wary of accelerating cash outflows from China and may need to use reserves to support the currency even as trade surpluses keep piling up.

More than 70 percent of economists said they predict that the balance sheet will be around the same size or bigger by the end of the year, in the survey of 21 institutions including Bank of China Ltd, Nomura Holdings Inc. and Societe Generale SA. Four economists said the balance sheet would expand, while six said it would contract further.

China’s policy makers said last month in their quarterly monetary policy report that the PBOC balance sheet involves more complicated factors than those of central banks in developed nations and can’t really be compared. Holdings are affected by foreign exchange purchases, monetary tools, fiscal policy, seasonal factors and financial reforms, it said.

“Shrinking the balance sheet doesn’t mean tightening monetary policy," the PBOC said in the report, adding that lowering the reserve requirement ratio for banks amid capital outflows may actually reduce the balance sheet while also easing monetary policy.

While the Fed and other developed-market central banks were busy rescuing their economies after the financial crisis by lending freely to banks and buying government assets, China through its trade surplus and foreign direct investment was already seeing massive capital inflows that it had to manage. The PBOC’s sterilization of those inflows -- buying foreign currencies and injecting yuan into the economy -- meant its balance sheet kept growing.

To ensure all that liquidity didn’t drive up inflation, the PBOC required banks to lock away increasing proportions of their deposits, driving that ratio to 21.5 percent for major lenders at the peak.

By now, even after a period of capital outflows and yuan depreciation that have seen the PBOC’s assets slip from a high of $5.5 trillion in 2014, foreign exchange still makes up about two thirds of the pile. In the context of expected Fed rate rises that could threaten a weaker yuan and a renewed liquidity squeeze in China, the PBOC can’t afford to relax its guard.

At the same time, China’s less-developed financial system means that the central bank’s monetary base still significantly underpins bank lending, though lenders are now creating more money per unit of central-bank cash than ever before. The so-called money multiplier is currently above 5, the highest-ever level.

Read More: China’s Monetary Turbocharger Is Running at an All-Time High

Even so, until growth in broad money -- M2 -- reaches the government’s target of 12 percent, there’s little cause to reduce the balance sheet, even amid a campaign to weed out excess leverage in the system.

All things considered, the balance sheet will stay stable this year as long as capital outflows remain subdued or halted, according to Ming Ming, a former central bank monetary policy official who’s now head of fixed-income research at Citic Securities Co. in Beijing.

"China’s economy hasn’t come to a situation where it can tighten monetary policy to the extent of balance-sheet shrinkage or assets sales," he said. "Monetary policy will remain smooth and neutral this year."

— With assistance by Yinan Zhao, Heng Xie, Xize Kang, Zheng Wu, and Cynthia Li

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