Chinese Monetary Policy
It's been an interesting set of events over the past week at the PBOC where a surprise monetary policy move last Friday jump started markets and was a welcomed surprise for me. With a 40 basis point cut on the one year and a rise on the deposit rate ban (the bank sets a target, currently 3% and banks are allowed to offer rates within a ban around this target) from 10% to 20% this move is a nice measured step down the liberalization path.
A New Direction for the PBOC?
Chinese monetary policy has long been exceedingly interesting and exceedingly boring. Most of the intrigue stems from it's complete lack of substance, direction, or really anything. I've been curious about when/if the role of monetary policy would expand as the ambitious transformation program takes hold in China.
We've all heard countless discussions about how there is a need to increase consumption levels relative to investment levels in order to establish a sustainable growth trajectory. Of course this is true at some level. In our western way, we typically preech doom and gloom and the coming cliff of 'whatever's around the corner'. This doesn't appear so for China (in my minority view). Yes growth is decreasing and debt levels are rising. But like the structural reform package there remains alot of low hanging fruit. Monetary policy seems to hold promise.
The economist has a good outline of the bank here:
Sudden shifts in the value of the yuan always bear the central bank’s fingerprints, but are infrequently explained. The motto for the People’s Bank of China (PBOC) should be: “If you know what we did, we must have done it wrong”.
... Yet real interest rates have climbed to more than 8% for industrial companies, since the prices at which they sell their wares are actually declining. That, in turn, makes debts much harder to service than anticipated. Cutting interest rates while enforcing capital rules to prevent banks from issuing a gusher of new loans would be a better way to rein in debt.Reducing that real debt burden is consistent with standard monetary policy of adjusting the base in accordance to more standard aggregate goals like inflation, employment, and GDP levels. Moves have been made this year, in targeted moves, in an attempt to re-allocate funds. Sectoral specific cuts in the reserve requirement ratio to encourage lending in the agriculture and smaller sized businesses was welcome. But beyond this, the PBOC still often fell into more fiscal styled actions (like the program with the Development Bank mentioned in the Economist article above).
While China's main concern should certainly be on the structural reforms mentioned above, monetary policy can and should play a central role. With the fiscal stimulus pumps set to push the infrastructure and investment based spending that risks exasperating the current imbalance, the government needs to be wary of turning on the fiscal taps.
The danger with monetary policy is that the financial system has long been set to push funds towards the SOEs that risk compounding problems as well.
I have been curious to see when the PBOC would begin more traditional monetary policy because I believe that this will indicate the state of progress in the financial system in the CPC's eyes. This is an important step.
Central to the reform package outlined at last year's Third Plennum (previous posts, here and here) was the notion that funds need to find their way into the hands of small and mid sized firms. Consumption habits would benefit from the liberalization of deposit rates. The ability for micro sized entrepreneurs to gain access to a larger pool of assets, akin to our small business lending facilities at our banks, would again push the reform goals in a manner that would also balance out bank portfolios and reduce dependence on the more murky portions of China's shadow banking sector.
A Surprise Move and More to Come?
PBOC's surprise move friday, described here, after big days Friday and Monday in Shanghai, Shenzhen and Hong Kong, it is clear that the markets hadn't price this move in. Perhaps more surprisingly, articles like this one are popping up discussing the likelihood of another rate cut:
"Top leaders have changed their views," said a senior economist at a government think-tank involved in internal policy discussions.
The economist, who declined to be named, said the People's Bank of China had shifted its focus toward broad-based stimulus and were open to more rate cuts as well as a cut to the banking industry's reserve requirement ratio (RRR), which effectively restricts the amount of capital available to fund loans.This is one aspect of the low hanging monetary fruit, and I believe is under appreciated in the most reports on China. Let's not forget that their falling economic growth is falling. It's not negative. Let's also not forget the scale of transformation going on here.
Over the past 5 years, due to both internal and external factors exports have fallen in importance. Chinese consumption of natural resources have fallen as the infrastructure mega projects that defined years of growth have taken a less prominent role in growth. Industrial and manufacturing weakness have been present for the past few years. All set against a background of a weak global economy.
Despite all the wisdom of the all the western experts, one thing must be noted: the scale of this purposeful transition has never been achieved before. Transitions are usually painful and externally imposed.
And of course, despite all the wisdom of all the western experts, another thing must be noted: the scale and uniqueness of China's success (as outlined by Summers & Pritchett here along with my thoughts). Leaves me with the feeling of: who better to attempt this restructure?
Assuming that the internal allocation mechanisms are improving, consistent with the rest of the reform agenda (I don't think we have any reason to believe they aren't), then reductions in the reserve requirements, liberalization of deposit rates, and a fall in official bank rates towards more western levels are an 'easy' path to a more standardized monetary policy regime.
This should be entertaining to watch unfold.