By Raymond Michaels – raymond.michaels@internationalbanker.com
The Chinese economy has undergone rapid growth over the past decades—with growth rates averaging 10 percent over the past 30 years—making it the fastest-growing major economy worldwide. Growth and the balance between domestic and foreign demand for Chinese goods and services are key focal points for Chinese monetary policy-setters over the short- and long-term horizon. China operates under a socialist-market-economy model and is the second-largest economy across the globe when looking at nominal GDP, and it is the world’s largest economy by purchasing power parity, according to the IMF (International Monetary Fund). As the world’s fastest-growing major economy, China is a global hub for manufacturing and is the largest manufacturing economy in the world as well as the largest exporter of goods. China is also the world’s fastest-growing consumer market and second-largest importer of goods. China is the largest trading nation in the world and plays a vital role in international trade, and has increasingly engaged in trade organizations and treaties in recent years. Further to this in 2001, China became a member of the World Trade Organization, and later in 2010 made a trade agreement with the ASEAN (Association of Southeast Asian Nations). In addition China currently holds free-trade agreements with several nations globally, including Pakistan and Switzerland.
Recent announcements from the Chinese central bank, the People’s Bank of China, indicate that they will be implementing a “prudent” monetary policy throughout 2015. This is a continuation of their stance from 2014 and has been designed to target and control growth in credit—keeping this figure within stable limits. Historically the Chinese central bank has positioned its policy such that it may tweak at policy parameters as it deems appropriate and necessary, and economic experts and forecasters consider this year to be no exception, despite the statements of a conservative approach. One of the Chinese central bank’s goals over the year will be to target, moderate or prevent altogether systemic risks developing in the Chinese financial system. This will be no small task as the economy has now gotten to a stage where a large proportion of banking and financial services and activities take place in the shadow-banking system—outside of the regulated arena—where risks have the potential to grow in unexpected and volatile ways.
The current Premier of the State Council of the People’s Republic of China Li Keqiang
The People’s Bank of China (PBOC), as the central bank of the People’s Republic of China, is the institution that has the power to control monetary policy and regulate financial institutions in mainland China. The People’s Bank of China has a greater amount of financial assets in its inventory than any single public institution, and is second only to the Federal Reserve System of the United States in terms of overall central-bank assets. Under the guidance of the State Council, the PBOC deals with drafting and implementing monetary policy. The most important aim of this is to maintain financial stability and the value of the currency in order to stimulate economic growth, to prevent or restrict financial risks and to safeguard financial stability. Other important tasks for the central bank of China include issuing and administering the circulation of the renminbi—the official currency of the People’s Republic of China, regulating the interbank lending market and the interbank bond market, managing the official foreign currency and gold reserves, recording foreign-exchange transactions and regulating the interbank trade in foreign currencies, managing the State Treasury, calculating financial statistics and producing research, analyses and forecasts, and participating in international financial activities on behalf of the central bank.
The recent statements from the People’s Bank of China renew previous commitments made by the central bank and are in line with the key policy goals of last year: to create a stabilising monetary policy whilst the Chinese economy faces speculation from parties worldwide that Beijing will need to take measures to boost growth and stave off deflationary pressures over the medium-term horizon. In particular, market participants, economic advisors and investors across the globe have been predicting that the Chinese central bank’s next move will be to loosen monetary policy to counter these risks to the Chinese economy—in particular forecasters expect the PBOC might implement a reduction to the reserve-requirement ratios for banks so as to stimulate the economy through the financial sector and increased lending. The most recently released economic data for China came out in December 2014 and indicated that consumer inflation for the year has remained in line with expectations at 1.5 percent. Further to this, according to recent statements made by the National Bureau of Statistics, the consumer price index for China rose 0.3 percent in December from November, which is in line with economists’ expectations. Analysts polled by Reuters had expected annual consumer inflation to be 1.5 percent for December 2014, up incrementally versus the 1.4-percent figure achieved in November 2014. However this figure has reached a five-year low for the East Asian economic powerhouse and obviously raises a number of concerns. The low inflation figure indicates persistent weakness in the Chinese economy and needs to be addressed effectively and in a timely manner by Chinese monetary policy setters—with many informed parties suggesting that policy setters would be wise to loosen monetary policy to stimulate and support growth within the domestic economy. In addition to concerns about inflation figures, the Chinese economy is suffering from a persistent downtrend in the housing and property market. To make matters worse, local business and local government bodies are struggling with their debt repayments across all levels of the economy—a major problem that advocates of loosening monetary policy by stimulating lending are quick to highlight.
China’s transportation system has created a significant disparity in the functionality of China’s domestic economy. In particular this has exacerbated the effect of differences in availability of certain resources between different regions within China—with massive disparities in infrastructure, natural and human resources; the gap between the industrial output of the various regions is glaringly wide. Economic development has occurred more rapidly in coastal regions as compared to the inner areas, and large disparities in per-capita income have developed over the past few years between the regions. The three wealthiest regions are along the southeast coast, centred on the Pearl River Delta; along the east coast, centred on the Lower Yangtze River; and near the Bohai Gulf, centred in the Beijing–Tianjin–Liaoning region. It is the rapid development of these three areas that is expected to have the most significant effect on the Asian regional economic output as a whole. Currently Chinese government policy is being designed and implemented to remove any obstacles to accelerated growth in these particularly wealthy regions. However, there are wider economic issues to be addressed for the nation other than bottom-line total GDP.
Deflation is a serious risk for China, and only through easing of monetary policy will growth and therefore prices and inflation be stimulated upward. The government target for consumer inflation is currently set at 3.5 percent. However, consumer inflation remained firmly under 2 percent for the entirety of the year of 2014. The Chinese central bank has some room to lower interest rates from their current level of 5.6 percent—but it would also be sensible to implement cuts to reserve ratios for banks to stimulate the credit economy. The Chinese interest rate in this case refers to the base interest rate. The central bank base interest rate or base rate is the PBOC’s basic interest rate over which the Chinese central bank has complete autonomy in setting along with the use of monetary instruments. This essentially means that the PBOC sets the interest rates for commercial banks, and therefore the PBOC has a lot of influence over the mechanisms and workings of the loans and mortgages market as well as those regarding savings and investments, and the commensurate interest paid on these instruments. The PBOC has indicated that it is looking to accelerate its policy of market-oriented interest-rate changes and at the same time move forward on increasing yuan convertibility in capital accounts. The Producer Price Index (PPI) in December fell 3.3 percent as compared to the December of the year earlier, reporting a consecutive monthly decline for the 34th time—which is a slightly greater fall than expected, as the market had forecast a 3.1-percent decline in producer prices following the 2.7-percent fall recorded in November. The PPI figure has shown the biggest decline since September 2012, which has been due to contracting demand that is hampering the pricing power of Chinese businesses. The decline in PPI has also been exacerbated by the continuing fall in oil and global energy prices. Over the course of the entire 2014 year, the Producer Price Index fell 1.9 percent.
The PBOC made an interest-rate cut in November of last year—which was the first time the PBOC had taken such action for greater than two years. The reason given by the PBOC was that the cut was to lower costs of borrowing and to hopefully support future growth—helping individuals and businesses achieve their economic goals. In addition, at the end of 2014, the PBOC took steps to reduce loan restrictions to further encourage banks to lend. Although the PBOC has the tools of cutting interest rates or lowering reserve requirement ratios (RRR) for banks at its disposal, certain economic experts and analysts are forecasting that the PBOC may be slow to implement these policy-easing measures and may instead choose to wait for actions taken through 2014 to take effect and push growth forward. It is forecast that China’s annual economic growth most likely showed slowing through 2014 to reach 7.2 percent in Q4 2014.This would be the weakest performance in growth in more than five years—the worst since the global financial crisis. A Reuters poll has furthermore indicated that full-year growth may fall short of the PBOC’s official target—experiencing the weakest pace in performance for 24 years.
As one of the world’s largest economies, China’s monetary and economic policies have an impact on the markets and economies of nations across the globe. With the progression of globalisation, all nations and their economic development are increasingly interconnected. This is particularly the case for the global banking and financial-services sectors. As the major economies across the globe suffer and contract, so too does the global banking sector. The banking sector has been under significant strain since the time of the global financial crisis—with the contraction of the credit market, weakening economic conditions and now with tough regulation placing even more strain on banking operations and balance sheets. The entire banking sector and capital-market activity have seen liquidity dry up. Just as for the US Federal Reserve, China’s central bank’s monetary policy has the potential to impact the international banking system. Known by some as the “G2”, the US and China are global superpowers— the economic policies and conditions of these nations have the power to boost or stifle growth for nations, economic regions, communities and businesses far and wide and of sizes both small and large. The yield on 10-year US Treasuries— a benchmark price of global lending –has jumped 20 basis points to 2.54 percent since autumn 2014, as it becomes clear that the US economy is moving into a phase of accelerating growth. US growth reached 4.2 percent in the second quarter of 2014, with the ISM manufacturing economic parameter almost reaching a 30-year peak level. Overall, the globally dominant central banks worldwide are indicating hawkish sentiments—looking to favour relatively higher interest rates in order to keep inflation in check. Central bank leaders in these nations are becoming somewhat less concerned with economic growth than they are with recessionary pressure brought to bear by high inflation rates.
Li Keqiang is the current premier of the State Council of the People’s Republic of China, and recent comments by China’s premier, at the World Economic Forum in Tianjin, warned that markets can no longer rely on easy access to capital—indicating that liquidity will be contracting over the horizon. At the forum, he commented that “we are restructuring instead of expanding the monetary supply”, expressing that the Communist Party is willing to risk an economic slowdown and will no longer be pushing an increased-credit agenda as a first priority. He also noted that a key target of policy setting is urban unemployment—which they would aim to maintain around the 5-percent level. As of the most recently reported figures, the Chinese economy is generating 1.2 million jobs each month. The changes the PBOC will be making to the Chinese budget may act to constrain borrowing to certain local governments and businesses, and fiscal tightening is also likely on the horizon. In addition regulatory action will be ramped up—as the PBOC seeks to bring the sizeable amount of shadow-banking activity into the lit, regulated and transparent banking arena.
Over the past five years, loans have gained in size from $9 trillion to $25 trillion for China—a figure that is equal in amount to that of the Japanese and US banking systems added together. Credit is at extremely high ratio levels, with estimates from Standard Chartered suggesting that credit exceeds 250 percent of GDP for the Chinese economy. The problems for the Chinese economy have stemmed from imbalanced growth—which has resulted from a growing dependence on external foreign demand—while debt has grown at an unmanageable speed, and asset prices have soared at a breakneck pace. Unsurprisingly the concerns of the Chinese economy have spill-over effects—in particular, Australia, Latin America and Middle East regions are feeling the squeeze as a result of Chinese economic conditions. These nations are inextricably linked to the Chinese economic climate through the commodities markets in particular, and are looking for indications from the PBOC on what they might expect for the next year in policy-setting and monetary measures. When it comes to commodities, oil is a primary concern for all nations across the globe, especially at this moment in time. China’s demand for oil has been slowing, and the International Energy Agency has furthermore recently cut its global demand forecast a second time for this month, commenting that they believe that “Chinese oil demand growth will struggle to get much above 2 percent”. However, the PBOC and its committee, quite the opposite to the US Federal Reserve in this regard, are not as forthcoming in vocalising forecasts and indications of what may come in the future in their announcements, leaving global parties and leaders unclear of how to position themselves and how to proceed with their own interrelated economic agendas. Policy announcements from the PBOC are few and far between, and when they do occur, they are at unpredictable times, sometimes popping up on the weekends without prior warning. This covert approach is not only unhelpful but has the potential to lead to dangerous consequences in today’s previously unseen market conditions.
The PBOC is also known for making sudden changes— especially when it comes to managing foreign-exchange levels and the value of the Chinese currency, the yuan. However they are not so well-known for providing guidance, explanation and reasoning behind these changes—often leaving economic experts and market participants perplexed as well as surprised by the course of action taken. In June of last year, the PBOC may have injected up to 1.8 trillion yuan ($294 billion) into the Chinese financial system through a variety of liquidity-boosting measures in order to bolster growth—amounting to greater than three months of the US quantitative-easing programme of bond purchases. However the PBOC only provided clarity and confirmation on whether this liquidity injection had occurred months later in November 2014. The approach of the PBOC has often been to maintain an unclear mixed-message stance whilst loosening monetary conditions. One reason for the lack of clarity may be that the PBOC is rumoured to be helping to provide cheaper medium-term capital to a select group of banks and does not wish to disclose this information. This approach is very unconventional, especially for a dominant global economic presence.
The PBOC has a difficult task in its midst. Designing and implementing regulatory measures to reduce soaring debts present in the shadow-banking system is a huge challenge in itself. The Chinese benchmark one-year lending rate is currently high at 6 percent, and going forward the best move for the PBOC would be to cut interest rates—as so many other nations across the globe have done so effectively over the past few years. The fears of the central bank are that it will be seen as weak if it now reverses its previous stance and chooses to carry out a rate-cutting policy. This may also be part of the reason for the lack of disclosure and public announcements. The PBOC has made a firm and public stance towards reducing debt and does not want to be seen as deviating from this standpoint. However the PBOC needs to remedy this type of action to help restore stability to the Chinese economy. By intervening in the financial system with random liquidity injections and in other unconventional ways, the PBOC is doing the financial system a disservice. This type of intervening risks undermining the integrity and sustainability of the entire banking system. The market needs the chance to operate and allocate under its own mechanism so that it may continue to do so from a position of stability and strength into the future. By intervening in the resource-allocation system— providing funds to some banks and not to others—the PBOC is disturbing the lending process and a core part of the economy.
In addition to this, the PBOC needs to start interacting with the public more effectively—communicating its reasoning and providing some forward guidance. The world is more globalised than ever, and uncertainty leads to volatility and vulnerability in markets across the globe. A key part of a central bank’s purpose is not just in the monetary policy itself but in providing investors and economic participants with some clarity and confidence to help the economy move forward and progress. Businesses and consumers will continue driving economic progress forward when there is a certain degree of confidence in market behaviour and consequently in their decision-making. Although the Chinese financial system is becoming more and more open, these shortcomings of the central bank have the potential to cause damage to China’s economy and beyond. China currently generates over a quarter of global growth. The yuan is more widely used than ever before, with central banks globally holding the Chinese currency in their foreign-exchange reserves. The Shanghai Stock Exchange has been opened up so that anyone with a Hong Kong brokerage account may invest in the market. The consequences of Chinese monetary policy have global impact, and the PBOC adopting best-practice changes would be a positive move for economic development, both domestically and beyond, for the future.