Beijing’s policy objective under President Xi Jinping has shifted from chasing growth quantity to pursuing growth quality. As a result, its policy reaction function has also changed from a bailout mode based on growth targets to a prudent stance based on structural reform needs.
As China’s economic growth loses momentum, senior leaders are debating whether to cut commercial banks’ reserve requirement ratio (RRR). Meanwhile, financial markets are trying to predict the timing of such a move.
If history is any guide, the People’s Bank of China (PBoC) should have cut the RRR by now. But it has not. This is mainly because the country’s economic and policy environment has moved into uncharted territories where Beijing has chosen to tolerate slower growth as a cost for forcing through structural reforms (see my article in this Real Insight section, “China growth slowdown engineered by choice”, May 19, 2014).
The last two RRR-cut cycles took place between September and December 2008, when the RRR was cut by a total of 250 basis points, and between December 2011 and May 2012 when it was cut by a combined 150bp. Growth in major economic indicators, such as credit, industrial output, electricity consumption, housing sales and corporate profits, contracted sharply in the run-up to the RRR cuts.
Growth of these indicators is now falling by at least as much as they did in the last two RRR cut cycles, except for corporate profits (Table 1). But the authorities have still not taken any action. Meanwhile, real interest rates have remained punitively high, with the average real one-year loan rate standing at over 7 percent, but average corporate margins are about 5 percent and shrinking. The real loan rates before the 2008 and 2011 RRR cuts were around 4 percent.
All this is evidence that Beijing’s policy reaction function has clearly shifted towards tolerating more economic pains in order to facilitate structural changes.
However, the economy has lost momentum so fast that it has caught Beijing by surprise and a stronger dose of stimulus may be needed. It is unclear if the mini-stimulus and “discriminatory” RRR cut for qualified rural banks implemented in April and May will be enough to stabilize GDP growth between 7 and 7.5 percent.
First, the mini-stimulus focuses on targeted infrastructure spending on power and transport, which account for about 21 percent of GDP. But real estate investment, which is now contracting, accounts for about 26 percent of GDP. So this targeted infrastructure spending may not be able to offset the contraction in the property sector.
Second, the rural banks have an average excess RRR of over 7 percent, compared with 2.3 percent for all other banks. The lower RRR may not necessarily prompt more rural bank lending.
If the economy fails to respond to the recent selective easing, further policy easing, including cuts in the RRR, is likely. However, Beijing’s prime goal is to balance growth with structural reform, so it is likely to refrain from using massive stimulus.
This begs the question: What form will monetary easing take?
An across-the-board cut in the RRR would be a last resort, in my view. Even within the PBoC, there is no universal support for such an action, as it would risk sending out the wrong signal that Beijing might be backing off from reform and resorting to wholesale bailout again.
The PBoC will continue to use a targeted-easing strategy, including “discriminatory” RRR cuts in the next moves for small financial institutions based in small cities and less developed parts of the country with heavy exposure to stressed sectors such as property.
Another targeted-easing measure is re-lending (which is simply direct PBoC lending to the policy banks). The central bank’s 300 billion yuan loan to the China Development Bank (CDB) through its re-lending facility in April was a start. It is reflective of the authorities’ goal of selective easing for sectors targeted for structural reform because the funds lent to the CDB were designated for renovating shantytowns and social housing construction, a priority in the structural reform agenda.
Universal easing measures will only be used if the selective easing measures fail.
The writer is Senior Economist at BNPP IP (Asia) Ltd.
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