Last night, in the wake of another freefall in the nation’s stock market and last Friday’s feeble Caixin manufacturing PMI report for August, China’s central bank – the PBOC – cut benchmark interest rates and injected liquidity into the financial system through a 50bps reduction to its reserve ratio requirement (RRR) for banks.
The former was somewhat unexpected, the latter was all but a given. Almost every market analyst covering China had penciled in further reductions to the RRR, both near and long-term.
Debate over the reason why the central bank decided to ease policy further continues to do the rounds this morning – some point to the recent two-day, 15% plus plunge on the stock market as the main catalyst behind the decision while others are speculating that deteriorating economic conditions, or tighter real money market rates, were also major factors.
Whatever the reason, the question many are now asking is what, if any, the additional policy easing will deliver to the Chinese economy?
From what we’ve read this morning, the analyst community isn’t convinced that it will have any meaningful impact on the real economy in isolation.
Li-Gang Liu, ANZ’s chief economist for greater China, certainly shares this view. In a note released overnight, Liu notes that the policy easing announced by the PBOC “was prompted by global market turmoil and continued fall in Shanghai market”, adding “traditional monetary policy easing, such as cutting RRR and lowering interest rate, is not sufficient to mitigate the risks associated with China’s highly leveraged economy”.
Liu believes “the risk of GDP growth falling to around 6% in Q3 has increased significantly”, and suggests that further liberalisation of Chinese financial markets will be required to help bolster flagging growth prospects in the quarters ahead.
“More financial liberalisation is also needed by allowing Chinese corporates and local governments to tap into the bond market with ease. The recent local government debt swap programme to exchange high interest maturing debt for longer tenor, low interest local government bonds will help to lower the risks of maturity mismatch. However, the next step is to expand the current programme further, allowing the provincial governments to issue debt without a quota. Instead, a strict fiscal rule should be put in place and the local government bond market should be monitored and disciplined by the markets. In addition, corporates should be encouraged to tap into the bond market as well to take advantage of the very low interest rates. Their switch to capital market for funding will create pressures for banks to take risks and lend more to the real economy”.
That is, local government bodies should be allowed to swap high-yielding, short-dated debt for lower-yielding, longer-duration debt – with appropriate fiscal monitoring – while corporates should be encouraged to tap capital markets, something that will provide them a cheaper source of funding.
If implemented correctly, less reliance on traditional funding sources may force Chinese banks to lend to sectors in the real economy, rather than financial markets.
Alongside the need for financial market reform, Liu believes that the easing seen overnight won’t be the last, predicting the reserve ratio requirement will be cut by an additional 50bps in the December quarter along with “additional targeted measures”.
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