MNI: Weak Credit Demand Limits PBOC Easing, Fiscal Move Needed

China's soft economic outlook and heavy debt burden has lowered the willingness of both private and local government sectors to add leverage and will limit the effectiveness of any future monetary easing the People’s Bank of China’s may want to undertake, policy advisors and economists told MNI.

Several advisors and economists concerned over the economic recovery have called for a greater loosening of monetary policy. A recent Institute of Finance and Banking at the Chinese Academy of Social Sciences (CASS) note suggested the PBOC should make larger and faster rate cuts to support the economy.

Lian Ping, chief economist at Zhixin Investment, told MNI the PBOC view of large and fast policy rate changes remains cautious, as the divergence between Chinese and U.S. monetary policy contributed to the yuan’s weakness over recent months. He said the central bank will likely maintain its small-scale easing to boost confidence and predicted a 25bp reserve requirement ratio cut this quarter to offset the maturing medium lending facility, followed by a key policy rate reduction in Q4. The U.S. Federal Reserve’s stance will become clearer then, Lian added.

But the economist noted this will depend on economic performance and policy room could exist, particularly if inflation remains low. He estimated Q2 GDP, due July 17, would print at 6.5%-7% y/y (see: MNI: China Q2 GDP Tipped At 7%).

INEFFECTIVE POLICY

PBOC data shows outstanding M2 supply rose 11.3% y/y in June, while M1 was down to 3.1% over the same period. The gap between M2 and M1 widened to historically high levels at 8.2% last month, indicating easing policy may not effectively bolster credit demand.

Liu Lei, senior fellow at National Institution for Finance and Development at the CASS, said the private sector’s low confidence is a key issue, rather than a lack of cheap funds. The average rate of new loan fell to a record low 3.95% at the end of Q1, while investment only expanded at a pace of 5.1% y/y at the end of 2022, he added. This compared to household deposits, which jumped by 17.3% y/y, and company savings, which gained 6.7% y/y.

The PBOC could face a liquidity trap in which low interest rates barely boost financing and investment, should the private sector deleverage, Liu warned. In addition, lenders' interest margin has been already soft and the capacity of the central bank to subsidise the banking sector had weakened after submitting over CNY1 trillion in profits to financial authorities in 2022, he added.

Fiscal stimulus, however, remains an urgent and useful option that could raise debt issuance and increase government spending to offset soft private-sector investment, which needs a higher deficit-to-GDP ratio from the current 3%, he suggested. The PBOC simultaneously should provide liquidity to financial institutions to help them buy government bonds, Liu added.

DEBATE CONTINUES

An advisor who asked for anonymity said debate among advisors and economists centered how strong any monetary policy response should be. Since senior policymakers are satisfied with H1 GDP over 5%, despite Q2 q/q growth slower than the 2.2% in Q1, the PBOC will likely make a small policy rate cut to boost confidence over bailing out the economy, he continued.

Lian predicted 2023 GDP will print about 5.5%, while external pressure will represent the major challenge to the economy thanks to weak exports. Policy supports would shore up domestic consumption and investment, particularly the property sector, he added. The next decade represents a crucial one for China to stabilise its economy and policymakers, particularly within fiscal policy, must respond to prevent any sign of the so called middle-income trap – the government has the ability to increase leverage, he suggested.

Ming Ming, chief FICC analyst of CITIC Securities, said structural monetary tools could work together with policies to boost domestic demand and consumption, and the PBOC will likely further guide down fixed-term deposit rates to unlock more savings.