Asia/Pacific October 03, 2019 / 08:36 am UTC

China Policy Watch: PBoC Not Loosening Monetary Conditions Excessively

By Jeff Ng

Our view is that the Peoples’ Bank of China (PBoC) will continue to gradually loosen monetary policy in 2019-2020. In times of slowing economic growth and threats of financial instability, the PBoC has kept its monetary policy accommodative without loosening excessively. This is brought about through mostly stable interest rate policy and some currency weakness. Even with economic growth momentum threatening on the downside, we do not expect the PBoC to be excessively concerned and intervene too much.

Figures 1 & 2: PBoC Maintains Loose Monetary Conditions After Deleveraging in 2017 (standard deviations); M2 Growth Stable Without Excessive PBoC Stimulus, while M0 Growth Rising From Liquidity Support

Source: Bloomberg, CEIC, Continuum Economics. Note: Monetary conditions compared to five-year moving averages

Monetary Conditions are Currently Loose but Unable to Boost Growth

We note that China’s monetary conditions have been loose since July 2018, when U.S./China trade tensions escalated (Figure 2). Monetary conditions have been looser compared to the five year average by 1 to 1.5 standard deviations, persisting for over a year. Conditions have been loose as the CNY weakened alongside risk averse conditions. In addition, China’s money market rates plummeted around the same time. Still, these have been unable to generate support for the real economy. We expect some 6% average y/y growth over the next few quarters, and see a 30% chance of GDP growth slipping below 6.1% y/y in Q3.

PBoC Unlikely to Intervene Excessively 

Currently, the PBoC has kept near-term liquidity (M0 growth) abundant but is not yet raising money supply (M2, Figure 2). It is likely that the PBoC sees little reason to intervene excessively, due to the limited potential effects of additional monetary stimulus. In addition, the PBoC has been concerned about high debt levels. We have been expecting a generally stable financial system, although there may be some bank bailouts to come

Currently, the PBoC is hoping that further decreases in market interest rates help support GDP growth. On September 27, a released PBoC statement highlighted using "market-oriented reforms to promote a noticeable decline in real interest rates.”

We expect the PBoC to maintain the 1-year lending and deposit rates at 4.35% and 1.5% respectively. Meanwhile, we see little changes with the 7-day reverse repo rate and the 1 year medium lending facility, currently at 2.9% and 3.3% respectively. The rate that China will tweak the most is the newly-introduced loan prime rate. We expect three cuts of 5 bps over the next 15 months, bringing the rate to 4.05% by end-2020. We also forecast five more reserve requirement ratio cuts by end-2020, designed to improve liquidity. Overall, these signal at policy stability with a bias toward accommodativeness. The Bank has also encouraged lending from stronger big banks in 2019. This can sustain overall credit growth, while still allowing some repair and restructuring in the second-tier banks and shadow banking system. 

The Meaning of “Stable” Currency Policy

We interpret China’s pledge of currency stability as gradual CNY weakness, particularly against the USD. China supported the CNY extensively in May to June and in August as the offshore CNY (CNH) led the weakness (Figure 4). This is mainly done through stable daily currency fixings. However, it also showed willingness in May and July to allow the currency to weaken as it allowed the currency fixing to move. Between now and end-2020, we see China allowing two to four rounds of currency pressures (mostly when the U.S./China trade war escalates) to move USDCNY higher to 7.40 end-2020. These should help to keep monetary conditions accommodative as China’s current account surplus fades in 2020 and GDP growth faces further downside risks.

Figure 3: PBoC Offered Currency Support in Times of Excessive Offshore Currency Weakness

Source: CEIC, Continuum Economics

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Analyst Certification
I, Jeff Ng, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.