ANZ: China is going to deliver stimulus following Brexit -- but don't expect anything heroic

Picture: Marvel

The Brexit vote has come and gone, with the UK opting to leave the European Union.

Following days of remarkable financial market volatility, akin to those seen at the height of the global financial crisis, investors are now wondering what will happen next.

What will it mean for the UK, the EU and global economy as a whole? These questions are likely to persist for some time yet.

No one really knows the answer, creating conditions that are hardly ideal for helping to spur on economic activity that continues to languish at sub-par levels, even before the Brexit impact hit.

With uncertainty set to dominate, and more importantly impact, over the period ahead, many expect policymakers — be they central bankers or politicians — to play a leading role in helping to right the ship.

As the largest contributor to global economic growth over the past decade, many are looking to China to lead the global response.

Compared to other advanced nations, it is one of the few countries that has both fiscal and monetary firepower ready and available to deploy.

More importantly, given its sheer size, any response will also be felt globally.

While the true economic fallout of the UK Brexit vote is yet to be felt, Raymond Yeung, senior economist at ANZ, believes that Chinese policymakers will definitely react.

However, and perhaps thankfully given the problems it has caused in subsequent years, he believes that a massive stimulus program akin to that implemented in 2008 is unlikely to eventuate.

“Unless the Chinese government believes Brexit is a global event similar to the level of the GFC, which is very unlikely, we do not expect China to repeat heroic action to save the world through massive pump priming,” says Yeung.

He suggests that deleveraging and capacity reduction, along with financial sector reforms, remain key policy considerations for the government, ensuring that a more measured response to the threat posed by Brexit is likely.

“We believe the government will attempt to offset the negative impact on growth and financial market volatility with a package of subtle policy measures,” says Yeung.

Continuing the theme seen in recent months, Yeung believes that an acceleration in infrastructure investment, along with liquidity support to the nation’s financial sector, will be at the forefront of the government’s response.

“We forecast that infrastructure spending will reach RMB12.2trn in 2016. Without Brexit, policymakers will still target another 20% increase for 2017 and lift the investment pipeline to RMB14.6trn in 2017,” he says.

“The government can consider frontloading a portion of this increment, say RMB1trn, to support growth, delivering a GDP impact of 0.7ppt [percentage points].”

As shown in the chart below, supplied by ANZ, the People’s Bank of China (PBOC) still has plenty of ammunition left on the monetary front, be it through reducing the banks’ reserve requirement ratio (RRR) or official interest rates.

It’s also clear that in past periods of financial stress, the PBOC have also tended to reduce the amount of cash that Chinese banks need to hold, rather than interest rates.

“Since the deflationary threat has diminished, the PBOC seems to be more inclined to manage liquidity conditions than lowering interest rate in the near term,” notes Yeung.

“Cutting the benchmark lending/deposit rates is unlikely. Instead, higher than usual reverse repo injections have worked well recently.

“To lift sentiment, the PBOC can also cut RRR. A 50bps cut of RRR will release liquidity of around RMB700bn into the banking system,” he adds.

The only question now is whether Chinese policymakers, like those in other major nations, see an urgent need to act. They, like us, will have little idea as to how it will all play out.

There are more questions than answers when it comes to the impact on the global economy.

One suspects that near-term economic data, along with levels of volatility in financial markets, will play a crucial role in determining if and by how much they react.

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