MNI EXCLUSIVE: PBOC Adds Liquidity As Growth Outlook Dims

Hefty liquidity injections by the People's Bank of China's have helped banks digest a surge in government bond issuance, but the PBOC will be reluctant to risk sending asset prices surging with more general easing measures even as it becomes less likely growth will reach as high as 3% this year, policy advisors told MNI.

The central bank's moves to pump a net CNY730 billion into the financial system in August via open market operations, its Medium-term Lending Facility and treasury deposits, came after liquidity levels tightened significantly in the preceding months, but Chen Daofu, deputy director at the Financial Research Institute of the Development Research Center of the State Council, said that this would be not a justification for further significant monetary loosening. Zhang Ming, a senior fellow at the Institute of World Economic and Politics under the Chinese Academy of Social Sciences, agreed, saying that the PBOC would be reluctant to risk fueling asset prices by moves such as cutting banks' reserve requirement ratios.

Banks' excess reserve ratio dropped to 1.1% in July from 2% in April, according to Tianfeng Securities, after the PBOC drained liquidity in both June and July. The ratio usually remains in a range between 1.5%-2%, said Chen, who expected the PBOC to maintain a neutral bias, tilting towards easing, for the rest of the year.

The amount of funds made available in August's liquidity injection, the biggest in any month this year and which came as government borrowing picks up in the wake of the Covid-19 pandemic, was roughly comparable to that of a 50 basis-point cut in reserve requirement ratios, which would release about CNY800 billion, PBOC data shows.

CAUTIOUS TURN

Frequent open market operations have in recent years grown in importance as a way of providing base money for the PBOC as its foreign exchange reserves have fallen, but it has had to become more cautious since May amid signs of excess inflows into property and stocks, said one advisor, who asked to remain anonymous.

At the same time, banks' needs for liquidity have risen as credit creation hits high levels, with the money multiplier rising to 7.15 from its usual 5-6, prompting the PBOC to inject funds to avert a liquidity crunch, the advisor said. If it is reluctant to run the risk of overheating the economy by cutting reserve requirement ratios, then it has to conduct open market operations more frequently, the advisor said.

Economic growth may reach only about 2% this year, marking a sharp rebound from the pandemic slump at the beginning of 2020, but falling short of earlier expectations for expansion of as much as 3%, according to the advisor. Gross domestic product would add about 5% in each of the two final quarters of the year, but there is a risk it could remain sluggish into 2021, despite a boost to first half growth numbers from this year's very low base comparison, the advisor said.

Some economists have been over-optimistic about the potential for a V-shaped jump in consumption and investment, the advisor said. Rates may eventually have to resume their falling trend in order to boost private investment and ease debt servicing costs for the government and state-owned companies, but this is unlikely any time soon, he said.

SURGICAL APPROACH

The PBOC, which has said policy moves will be tend to be targeted at specific parts of the economy rather than across-the-board, has to take a surgical approach to easing due to the limited transmission capacity of China's financial markets, which do not efficiently pass on additional funds to small businesses in particular, said Tang Min, a counsellor at the State Council.

But the anonymous advisor said that this approach brought other risks. The PBOC is effectively taking on some areas of fiscal policy and could fuel arbitrage and prompt growth in bad loans by encouraging banks to lend to small businesses.

Some small banks already face bad loan ratios of more than 10%, and a target set by the China Banking and Insurance Regulatory Commission of limiting write-offs of bad loans to about CNY3.4 trillion this year already looks over-optimistic, the advisor said.

While China's provinces now all have their own asset management companies which could help deal with bad loans, local governments are also having to contend with drops in revenue, he said.