China’s central bank tries to save the economy—and the stockmarket
Summary
- But it will need more help from government spending
As China’s economy has descended into deflation, the central bank’s lack of urgency has been a source of frustration. Officials at the People’s Bank of China (PBoC) at first expressed confidence that deflation was, so to speak, transitory. When it persisted, they worried less about falling prices than about the side-effects of fighting them. They were reluctant to ease monetary policy decisively as China’s currency was too weak, banks’ profit margins too slim and bond yields too low.
But at a press conference on September 24th the central bank revealed a change of heart. It announced a set of policies that were unusually bold. It said it would cut its policy interest rate by 0.2 percentage points, lower banks’ reserve requirements by half a percentage point and reduce interest rates on existing mortgages by about half a percentage point. It is unusual for China’s central bank to ease on two fronts at once, let alone three.
Pan Gongsheng, the PBoC’s governor, said it might do more in the near future, perhaps cutting reserve requirements by another quarter- or half-point this year. Such “forward guidance" is unprecedented in China, notes Morgan Stanley, a bank.
The press briefing yielded another surprise. China’s central bank already has a variety of “structural" tools to help industries as diverse as clean coal and care for the elderly. Now it has come up with a similar innovation to support the stockmarket, Mr Pan said. It will help firms buy back their own shares by refinancing bank loans used for that purpose. And it will help securities companies and other institutional investors to raise funds by making their balance-sheets more liquid. They will be able to borrow liquid assets like government bonds and central-bank bills from the PBoC, using their own holdings of blue-chip shares and stock ETFs as collateral.
What accounts for the central bank’s boldness? Fear is a motive. Economic data for August were discouraging and China is in danger of missing its official GDP-growth target this year of “around 5%". Earlier this month Yi Gang, the bank’s former governor, said that China “should focus on fighting deflationary pressure".
The central bank has also become less afraid of the side-effects of that fight. When America’s Federal Reserve cut interest rates by half a percentage point last week, it gave China’s central bank room to move. It could lower its own interest rates without dangerously weakening its currency. The yuan has in fact strengthened by 3% against the dollar since the end of July.
Mr Pan also thinks his new package will have a “neutral" effect on bank profits. Monetary easing can have the unfortunate effect of squeezing bank margins, as loan rates tend to fall faster than deposit rates. But Mr Pan hopes that the rates banks pay and charge will fall in tandem, leaving the margin between them largely intact.
Cutting interest rates on existing mortgages could nonetheless hurt the banks. Chinese home loans are difficult to refinance. So when interest rates fall, older mortgages tend to have higher interest rates than newer ones. Reducing that gap will save 50m households about 150bn yuan ($21bn) a year, equal to 2.5% of their disposable income, according to Goldman Sachs, a bank. At the same time, it will deprive banks of an equivalent sum. Their only consolation is that the policy will also discourage early repayment of mortgages, which was another threat to their profits. And Mr Pan accepts that banks will prepare carefully before implementing the new policy. “So don’t run to the bank this afternoon," he quipped.
Even if old mortgage rates were reduced in an afternoon, however, it would not bring immediate relief to China’s economy. Household savings of 150bn yuan might translate into extra consumer spending of only 53bn yuan, according to Raymond Yeung of ANZ, another bank. That is less than 0.05% of China’s projected GDP for this year. “More demand-side measures are needed," he counsels.
The bulk of those measures will have to come not from the central bank but from China’s fiscal authorities. They may announce an increase in China’s budget deficit later this year, as they did last year, according to Xing Zhaopeng, also of ANZ. Local governments might also issue more bonds than planned, since they have not used all of the quotas assigned to them. With reduced interest rates and low bond yields, the central bank has “created a good monetary environment for China to implement a proactive fiscal policy", Mr Pan said at the press conference. With luck, China’s government will take the hint.
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