MNI INTERVIEW 2: China Fiscal Expansion Crucial, RRR Cut Eyed

Central government fiscal stimulus will be essential for dealing with China’s current economic situation, but in the long term the country will need to look to equity-funded tech innovation and manufacturing upgrades to drive growth, a prominent economist told MNI, also predicting the central bank would reduce reserve requirement ratios by 25 basis points later this year.

Fiscal stimulus is necessary to avert a self-reinforcing cycle of weakening demand for risky assets, said Peng Wensheng, chief economist at the China International Capital Corporation Limited, noting that “market forces may not be able to reach an ideal equilibrium on their own” and calling for more central government borrowing in response.

Weak demand has been driven by factors such as global supply chain adjustments and long-term effects of the pandemic, as well as by the financial cycle, said Peng, who participated in Premier Li Qiang’s advisory meeting in April.

“We have seen some signs of improvement in demand thanks to policy efforts, but further policy supports are needed” he said in an interview. Both additional central government spending and balance sheet expansion by the People’s Bank of China will be required, he said, though fiscal policy should take priority given weak demand for credit.(See MNI INTERVIEW: China AI Needs Green Electricity Investment)

“We should not underestimate innovation from the policy side,” Peng said.

Increased transfer payments to vulnerable groups, incorporating more unemployed individuals into the social security system, and enhancing subsidies to encourage childbirth would increase the share of household income in national income and boost consumption, he said.

Reforms of taxation, including a reduction in value-added tax and other taxes on turnover, together with a shift to more direct taxation, would also help to reduce income disparities, he added.

MONETARY POLICY

“We expect the PBOC to cut the reserve requirement ratio by 25bp in the rest of this year, equivalent to an additional liquidity injection of CNY500 billion. The PBOC may also guide lending rates down,” he said.(See MNI: Chances Rise PBOC Cuts RRR As Gov Debt Issuance Increases)

The central bank is also likely to accelerate the pace of relending for technological innovation and affordable housing, while growth in money supply may remain flat in the next few months as authorities limit the misuse of funds for non-productive financial arbitrage.

Peng noted that past experience shows a rising gap between money expansion and total social financing growth may add to interest rate fluctuations.

EQUITY MARKETS

Equity financing will be essential for the next phase of Chinese growth, according to Peng, particularly that coming from smaller exchanges established under the “multi-layer” capital market initiative in 2003 aimed at providing more finance for innovative companies.(See MNI INTERVIEW2: China Green Transition To Boost Manufacturing)

These include the Science and Technology Innovation Board (STAR market) set up by the Shanghai Stock Exchange in 2019, the Growth Enterprise Market Board established by the Shenzhen Stock Exchange in 2012 and the National Equities Exchange and Quotation over-the-counter market set up in Beijing in 2006.

“Innovation by nature has higher risks and a long-term investment horizon, and bank loans may not demonstrate a strong advantage in supporting that,” said Peng. “From the main board to the STAR market, Chinese equity markets are increasingly enriching service to the innovation… and regulatory authorities have been taking measures to increase the protection of small investors.”