Effectiveness of PBOC’s monetary easing will be limited by deleveraging5 September, 2012, 12:54. Posted by Zarathustra
This is part 4 of 7 in the series China Economy: Hard Landing and Beyond
Original version appeared on 26 August
Funds flow is now constraining the People’s Bank of China’s ability to ease monetary policy in a sense that it stopped the main driver of PBOC’s balance sheet expansion from working, i.e. foreign reserve accumulation. But fear not, there are other ways to circumvent this problem, if China does want to ease further.
Previously sterilised funds inflow can be un-sterilised by cutting reserve requirement ratio aggressively (until it can be cut no further), reverse repo can be conducted more frequently and at larger sizes, central bank bills might be redeemed, and eventually going down the route of large scale asset purchases programme, i.e. quantitative easing as we know it.
There will be other implications, of course, and the more aggressive it gets, the more considerations have to be taken into account. For instance, Chinese Yuan might be made weaker by large scale asset purchase programme, and the perceived depreciation pressure might trigger even more funds outflow. The government (as well as the public) might also be worried about the risk of high inflation (although we believe there is no such risk in the long run due to massive overcapacity).
But there is one more fundamental problem China is facing which makes monetary policy not going to work, even though PBOC may eventually perform quantitative easing-like operations.
The chart below from Bank of America Merrill Lynch, which we showed earlier in the series, illustrates the problem (from the same note we mentioned about zombies). With the exception of household debt, the debt-to-GDP ratio for other sectors are not much different between China in 2010 and the pre-bubble-burst Japan.
Source: Bank of America Merrill Lynch
We all know what happened next to Japan. Corporate sector was deleveraging after the real estate bubble burst, while the government went into massive deficit spending for years which helped to avoid any dramatic contraction of the economy. Deleveraging might have been finished for Japan’s corporate sector, but the public sector’s deb-to-GDP ratio has well exceeded 200%. This is not a very surprising result. Government debt levels often rise after a severe recession, particularly after a financial crisis.
The level of debt in China is a bit of a mystery, and we will not be surprised at all if someone manages to find more. However, getting the debt level precisely right is hardly the main issue here. Rather, the issue here is what implication it has on the effectiveness of monetary policy.
The problem is with corporate debt level at about 100% of GDP (previously some estimated that at 107% of GDP), with massive overcapacity and low returns on investments, is that the level of debt will be unsustainable, as we mentioned in the early part of the series, thus deleveraging will be needed. For the purpose of argument, we now assume that without any government intervention and fiscal stimulus, that as economic activities will slow much further than what we are currently seeing, and that is going to impact employment and income of households, thus it does not seem reasonable to assume that household can possibility pick up the slack, by borrowing more and spending more, especially as we have a real estate market that will, in our view, eventually fall much further despite recent resilience. Without any government intervention and fiscal stimulus, we think demand for credits will be extremely weak as private sector deleverages by repaying debts and/or default.
It is true that the Chinese banking system have a slight liquidity issues here, and credit standard is getting higher as perceived risks are high, and that should have contributed in part to the generally not-so-great loans numbers we get on a monthly basis. However, even if the PBOC cut RRR much more aggressive, eventually cut rates to very low level, and perform large-scale asset purchase to ease liquidity in the banking system and bring down interest rates, we suspect that in such a debt deflationary environment, demand for credit will just remain as low.
There is little doubt in our mind that if the government intend to maintain growth at high level, there is no option except to take on more debt, increase deficit spending, and investing more into overcapacity, meanwhile instructing banks not to cut odd credits to struggling companies for the sake of keeping jobs and productions. The choice between doing absolutely nothing and doing everything to save economic growth, however, is not an easy one.
- China Economy: Hard Landing and Beyond
- China’s overinvestment: the problem of having too much
- China’s “little” debt problem
- Chinese central bank’s ability to ease monetary policy is constrained by outflow
- Effectiveness of PBOC’s monetary easing will be limited by deleveraging
- China’s difficult choice between stimulating the economy and not
- China’s hard landing is not the end of the world