A worrying run of data has dialed up calls for help to boost China’s economy. The central bank has answered with a flurry of rate cuts that analysts view as a welcome sign of action. But a number of restraints, from a weak currency to banks’ falling profitability, lead many to think that ultimately, it is fiscal policy that needs to come to the rescue.
On Monday, the People’s Bank of China unexpectedly trimmed a key short-term policy rate for the first time since last summer, saying it aims to ramp up support for the economy. That was followed by banks lowering benchmark lending rates they use to price the country’s commercial loans, including mortgages.
The PBOC also announced cuts to interest rates on the standing lending facility, a monetary tool that provides short-term loans to banks.
All this comes on the heels of a key political summit during which leaders recommitted to achieving this year’s economic growth target of around 5%, despite a sharper-than-expected slowdown in the second quarter. At the agenda-setting Third Plenum gathering last week, the ruling Communist Party expressed concern about the country’s recent economic performance and pledged more support.
“The PBOC clearly wants to be seen to be doing its part,” Capital Economics said in a note.
Analysts had long been expecting the central bank to ease monetary policy to boost the economy, but say it has a tough task in doing that while also stabilizing long-term bond yields and the yuan. Front-running the Federal Reserve could widen the rate differential with the U.S., pressuring the currency. Slimming profit margins at many Chinese banks also make the case for rate cuts less compelling.
There are also doubts that rate cuts will pack the punch needed to jolt the economy back into action.
“The reality is that small cuts…will make little difference to economic activity,” said Julian Evans-Pritchard, head of China economics at Capital Economics. “If the PBOC is serious about monetary stimulus, it should cut rates much more substantially.”
Lowered rates will at best deliver a limited boost to the beleaguered property sector and tepid consumer demand, said economists at Pantheon Macroeconomics.
“Housing demand won’t be revived easily with a couple of token rate cuts,” they said, “the problem lies with its supply overhang.”
The impact elsewhere, like in the high-tech strategic sectors that are China’s new economic growth engines, is also limited as these are less credit-intensive areas of industry, Pantheon Macroeconomics said.
The push to lower borrowing costs comes against a backdrop of listless consumer and corporate demand for credit, as confidence in the economy remains low and uncertainty high.
That weakness in demand rather than loan supply means PBOC can’t turn to loosening quantitative controls on bank lending to amplify the impact of rate cuts, said Evans-Pritchard.
“The central bank is faced with a dilemma: it needs to stimulate a sluggish economy that is suffering from the housing crisis but also needs to fulfill its mandate of a ‘powerful currency’ and project an image of robust long-term fundamentals,” Nomura economists said in a note.
Monday’s moves follow a policy framework revamp the PBOC has been carrying out as it tries to get a better grip on bond markets and bolster the yuan. A monthslong bond bull run fueled by demand for safe-haven assets has pushed long-term yields to record lows, sparking warnings from authorities about financial instability and yuan depreciation.
Despite the wave of rate cuts, economists say the central bank is still determined in shoring up long-term yields, evidenced by its Monday cut on the collateral requirement for its Medium-Term Lending Facilities, or MLF. Earlier this month, the PBOC had also signed agreements with major lenders to borrow “hundreds of billions” of yuan worth of government bonds for potential bond sales, in a move that economists say will put a floor under longer-term yields.
The temporary collateral reduction or exemption for MLF funding could partially mitigate the potential liquidity drains from the PBOC’s planned treasury bond borrowing as such bonds are the main collateral pledged by banks for MLF loans, according to Nomura’s economists. It would help the PBOC borrow bonds from banks while maintaining the availability of government bonds as collateral for banks, they added.
Though unconvinced about the impact of the announced cuts, economists see room for more PBOC easing ahead, particularly once the Federal Reserve’s easing cycle kicks off.
The Chinese central bank also has other tricks up its sleeve, and could ramp up re-lending facilities to help fund local governments’ efforts to buy up unsold properties to turn into affordable housing, the Pantheon Macroeconomics economists said.
Another option could be to press commercial banks to cut existing mortgage rates, according to Nomura economists led by Ting Lu. Doing this would address the gap between existing and new mortgage rates that the economists say is a source of discontent among borrowers.
Ultimately, however, it will be fiscal stimulus that will likely shoulder the bigger burden in efforts to revive the economy, analysts say.
Fortunately, signs on that front are encouraging, said economists at Capital Economics, with senior officials signaling the acceleration of government borrowing and spending over the coming months.
Morgan Stanley economists also pointed out that at a meeting Friday the State Council said long-term government bonds can be used more flexibly for the consumer goods trade-in and capex upgrading program, “easing the constraint that long-term bonds can only be used to finance infrastructure projects.”
For analysts, more concrete measures on both the fiscal and monetary front are needed to address the country’s structural economic challenges. All eyes will now be even more attuned to the end-of-July Politburo meeting, where expectations of bolder policy are high, and the scope for disappointment is big.