The other shoe has finally dropped. The United States announced on Dec. 18 it would start winding down its quantitative easing (QE) policy in January.
Generally speaking, the US move offers a chance for China to accelerate its economic restructuring. If Beijing can strike a balance between properly handling the financial risks and promoting economic reforms in the aftermath of possible capital outflows, the US move will bring more good than harm. First of all, there is no need to worry that the US policy will cause a capital shortage in China.
It is true that the tapering of the massive bond buying program will prompt international capital to leave emerging markets, including China, for the US market. The Shanghai Interbank Offered Rate peaked at 4.515 percent on Dec. 23, a percentage point higher than the level before the US announced its pullback from the QE policy.
But the recent credit squeeze should be viewed as part of the seasonal changes in the money market. Chinese banks often recall money at the end of each year to boost their capital adequacy ratio in an effort to polish up their balance sheets. In the past two years, interbank rates were usually about 100 points higher than those in the previous month. In this sense, the recent rate jump is within a reasonable range.
Considering China’s lending growth rate, high saving ratio and huge turnovers in the stock market, the country has never been short of money in absolute terms. And the authorities have plenty of financial tools to maintain the stability of interest rates.
Therefore, after the central bank conducted the reverse-repurchase, the Shanghai interbank rate quickly waned to 3.513 percent on Dec. 27.
This case shows that what the market worries about is not the US policy but the central bank’s inaction.
The US policy provides a golden opportunity for China to continue to deleverage its economy. With the US monetary stance gradually and slowly tightening, China will follow suit.
Since the 2008 global financial crisis, the QE program has resulted in a global credit boom. China witnessed easy credit on both the domestic and international fronts, with global hot money flowing to the country and its government rolling out massive stimulus amid a money printing fever.
That resulted in growing debt levels in China, forcing the country to park a large amount of money in the property market and resulting in a situation where the property market has hijacked other industries.
About 60 percent of China’s loans are estimated to have gone to the land and property markets directly or indirectly. With money parked in this single sector, other industries have limited access to funds.
Now that the US is tapering off its QE policy, money will gradually flow out of China. China’s property market will bear the brunt of this capital outflow, as can been seen in a recent property price drop in major cities such as Beijing.
That will help rebalance the loan market by cutting overall debt levels and reducing leverage ratio in the property market.
The US move may also be good to China’s trade sector.
First, it will help bring down commodity prices, as reflected in the recent drop in the price of gold. China is a major commodity importer, so cheaper commodities such as oil and iron ore will help the country cut its overall costs.
Moreover, the tapering shows that the US economic recovery is solid, which means larger US demand for Chinese goods. Chinese exports to the US saw an 11 percent jump in November. Continued US recovery may speed up the recovery in China’s manufacturing and trade sectors.
But during this process, China must be aware of a few things.
It must avoid a financial crisis. Although structural risks in China’s financial system are low, it cannot be denied that partial financial meltdowns are a distinct possibility. In fact, debt risks and money shortages are evident in some regions such as Jiangsu and Zhejiang provinces, where private lending chains have broken.
China should also keep an eye on possible demand drop in other emerging markets, where currency depreciation and money outflows have shaken local economies.
In addition, China should stick to — or better yet, tighten — its policies on environment, restructuring and the property market even as its manufacturing industry recovers. Othewise, low-level manufacturing will make a comeback.
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