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