Zhou Xiaochuan, the governor of the People’s Bank of China, was quoted two days ago saying that the PBOC will not rule out any possible monetary policy tools at their disposal (via China Securities Journal).
Zhou Xiaochuan was asked about future policy in the context of massive liquidity injection through reverse repo operations. The market has been hoping for some a cut of reserve requirement ratio (RRR) almost every week now, so the lack of RRR cut together with continuous reverse repo operations leave some wondering if RRR is no longer a preferred tools.
Governor Zhou said no tools will be ruled out.
Given that the economy has been slowing much worse than even some of the pessimistic forecasters (like ourselves) have been expecting, and that the real situation is probably even worse than official data suggest, there is every reason to believe that both the government and the PBOC has to ease (although not yet, as we have said repeatedly).
1. Interest rates;
2. Reserve requirement ratio;
3. Reverse repo;
4. Window guidance (or as we called it, state-directed lending or simply forced lending).
Before proceeding, we would like to mention that the net injection through reverse repo since July or so has been so large that it has exceeded the amount that would have been freed up by one RRR cut. So obviously one should not just beg for RRR cuts. On the negative side, however, even with such a large scale injection, the interbank liquidity is not really helped much. This is consistent with our view that in a debt deflationary environment with rising bad debts and persistent (although slow) money outflow, liquidity will become a problem, and cutting RRR and reverse repo merely offset the liquidity tightening. In fact, what we are seeing right now is less than able to offset the tightening, let alone actual easing.
As Zhou Xiaochuan is not ruling out any tools, there is one possibility that has been mentioned before, yet is not getting much attention (even bulls are not discussing this, which is a surprise): government bond buying, as we mentioned before that some who are close to the central thinks that bond purchases in the secondary market could be the next channel for base money creation.
The rationale for government bond buying by the PBOC at the moment is not immediately obvious, and it is certainly not one of the policy tools that the PBOC has used often. Indeed, as Dong Tao of Credit Suisse previously pointed out, claims on government only represents a very small part of PBOC’s balance sheet. For most of the time in the past decade or so, the PBOC creates base money as massive trade surplus and capital inflow necessitates foreign exchange intervention to keep Chinese Yuan from rising too quickly. As we have repeatedly said, this trend is no longer there, thus PBOC can no longer create money in a way as it did. In fact, they need to withdraw money from the system now (by selling FX assets) in order to prevent Chinese Yuan from falling. Of course, nothing very dramatic is happening as everything is unfolding slowly. But surely, this is happening.
RRR has been used to sterilise inflow, which “locked up” liquidity from the banking system, so to speak. PBOC can “unlock” this previously “locked” liquidity by cutting RRR as liquidity tightens, but there is only so much that you can “unlock”: you obviously can only reduce RRR to zero at the very most, for instance. Ultimately, if things are getting really bad, PBOC needs to actually create money by buying something. Or, the PBOC needs to expand their balance sheet. But instead of buying foreign assets as it did, PBOC needs to buy something else when there is no longer large capital inflow and trade surplus. Government bond is a very logical destination.
A large-scale asset purchase programme (a.k.a. quantitative easing) is not without problem for China, and there are many reasons not to expect that to happen any time soon. Despite deleveraging and overcapacity, potential inflation and the resilience of the real estate market remains a concern for many Chinese, including the leaders. Indeed, as the experience in the US shows, despite lack of threat of (hyper)inflation, many people continue to believe that such risk exists. Not to mention that the Chinese central bank has been a champion of “printing money”, and everyone knows and loathes it. As the expectation of Chinese Yuan depreciation is building up, QE-ish operation will only increase that further. In today’s environment, the PBOC can’t possibly do this.
However, given the on-going trend of very weak economic activities and the liquidity tightening arises from outflow and possibly rising bad loans, we suspect there will come a point when even cutting RRR aggressively will not be enough to maintain liquidity condition, and that will necessitate some asset purchases programme in one form or another. The timing of the possible asset purchases in unclear, but we think ultimately that could happen when things get really bad. And for now, it is not bad enough.
This article originally appeared here: The policy tool PBOC has when China’s economy gets really bad
Also sprach Analyst – World & China Economy, Global Finance, Real Estate
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