21 September 2019
The PBoC's cuts at the weekend are not just an old-style bailout of the stock market but part of a strategy to restructure the economy. Photo: Bloomberg
The PBoC's cuts at the weekend are not just an old-style bailout of the stock market but part of a strategy to restructure the economy. Photo: Bloomberg

China’s two-prong monetary easing and the stock market

I do not intend to add to the market chatter over Saturday’s cuts by the People’s Bank of China of 25 basis points (0.25 percentage point) in lending and deposit rates and its 50 bps cut in selected banks’ required reserve ratio.

But there are a few issues relevant to Chinese stocks and bonds that I want to share my thoughts on.

First, the two-prong monetary easing (interest rate cuts plus RRR cut) is not a sign of policy panic by Beijing, in my view, despite its coming after the 18.8 percent drop in A-share prices in just two weeks, between June 12 and 26.

Some may call the easing a “PBoC put” to salvage the stock market to prevent a potential systemic risk, just like the “Greenspan put” in 1987, when an interest rate cut by the US Federal Reserve helped the market recover from a crash.

But the fundamental reason for further monetary easing is still the same – a weak economy with the threat of deflation.

The sharp and rapid fall in the A-share market just gives Beijing more room to manoeuvre.

Second, Beijing does not have a policy that targets the stock market, in my view, as the potential damage from a negative wealth effect stemming from falling stock prices in China is limited.

The Chinese authorities do have a policy to support growth of the stock market as a tool to facilitate financial reform, as Beijing wants to reduce the reliance of the economy on bank lending and increase the role of capital markets in funding growth.

A strong and large stock market, with capital market reforms, is needed.

From this perspective, the two-prong easing is aimed at stabilising investors’ sentiment and facilitating the long-term growth of the stock market to assist financial rebalancing.

Third, this is not a broad-based monetary bailout.

In China’s case, an interest rate cut mainly lowers the cost of capital but does not add liquidity.

The liquidity injection comes from the cut in the RRR.

This time, the 50 bps RRR cut applies only to targeted banks that meet the PBoC’s standards for supporting small and medium-sized enterprises and the agricultural sector.

The amount of liquidity injected is expected to be not more than 650 billion yuan (US$104.8 billion).

This reflects Beijing’s determination not to go back to the old model of economic bailout by blanket liquidity injection and, hence, its resolve to achieve structural reform in the economy by managing systemic risk.

Fourth, the RRR cut is not a sign of the faltering of China’s deleveraging efforts.

We have argued that China’s headline leverage might indeed remain high but would grow at a slower pace.

It is impossible to impose outright deleveraging on a weakening economy.

The RRR cut may boost credit growth and underscore this argument.

But this is well within Beijing’s plan to deleverage by stealth (lowering the overall debt burden by reducing interest payments) through a combination of a debt swap program for local governments and a revision to the Budget Law.

Deleveraging will continue to reduce China’s systemic risk premium over time.

Fifth, the two-prong easing is unlikely to prompt a persistent decline in the renminbi.

The PBoC’s policy of pursuing a stable renminbi with a small appreciation bias is clearly seen in its daily fixing.

China’s bid for the renminbi to become part of the International Monetary Fund’s special drawing rights basket and eventually a global reserve currency (through renminbi internationalization) adds to the political motive of keeping a strong renminbi in the medium term.

With the capital account still relatively closed, divergence between the US and Chinese interest rate cycles is not enough to cause sustained weakness in the renminbi exchange rate.

Last, but not least, the fundamental and structural reasons for rerating Chinese assets (stocks and bonds alike) remain unchanged, despite the recent market volatility.

Cyclically, there is still room for interest rate and RRR cuts.

I expect at least another 25 bps interest rate cut and 100 bps in RRR cuts for the rest of the year, with more to come if the economy fails to stabilize.

Beijing does not mind tolerating a strong renminbi and using it as a macro tool for pushing through structural changes.

Continued asset reallocation by Chinese onshore investors into stocks and further expansion of avenues for foreign investors to access the onshore stock market will support a medium-term uptrend for A shares, albeit with high volatility.

The same argument can be made for Chinese fixed-income assets.

The country will continue to deleverage, alongside other structural reform initiatives, by opening up the financial system to market discipline.

New reform initiatives have been rolling out both in the economic, financial and fiscal aspects for economic rebalancing.

The government’s reforms have been tested and proven so far.

In a nutshell, China is the country that has the most significant amount of structural reforms unfolding.

This is the strongest reason investors should gain exposure to Chinese assets for medium- to long-term gain.

Opinions expressed here are the author’s and do not necessarily reflect those of BNPP IP

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”