MNI: PBOC Faces Calls For Caution As It Normalises Policy

The People's Bank of China, curbing credit growth to avoid fueling bubbles after its Covid stimulus, is facing calls from some advisors and economists to be cautious as it further normalises policy, amid doubts over how long a surge in exports can last and concerns over weak consumption.

With annual inflation under control and reluctant to push up rates to levels which might stress local government finances, the PBOC should keep its policy bias tilted towards easy in the second half of the year, Zhang Ming, deputy director of the Institute of Finance and Banking under the Chinese Academy of Social Sciences, told MNI.

While the PBOC has indicated it intends to continue to normalise policy, tightening should only be gradual, particularly given the withdrawal of fiscal support, said Zhang, pointing to the unbalanced nature of China's recovery, with industry bouncing back thanks to cheap loans and overseas demand even as consumption trends have remained tepid.

The PBOC stance could result in a widening policy divergence with the Federal Reserve, which is moving towards tapering bond purchases, he said, adding that the yuan could strengthen to as much as 6.3 to the dollar in the next three months before weakening to 6.8 in Q4 from 6.46 now. Chinese equity and bond markets could also see declines in the fourth quarter as U.S. growth possibly outpaces China's in Q4, Zhang said.

CREDIT TIGHTENING

For the moment, the central bank is continuing to normalise, according to gauges of money supply and credit, including M2, total social financing and new yuan-denominated loans. But the rate of growth in fiscal spending slid to 3.6% y/y in the first five months of the year even as revenues jumped by 24.2% in the same period.

Guan Tao, a former Director General of Balance of Payments at the State Administration of Foreign Exchange, agreed PBOC polices should remain supportive. Average growth from 2020 to 2021 is likely to end up a little over 5%, down from 6% in 2019 and the lowest in nearly three decades, he said. Investment supported by credit may have to play a key role in maintaining momentum if currently robust exports lose speed and if consumption does not pick up, he said.

A withdrawal of PBOC support could also undermine market sentiment, Guan cautioned, stressing that domestic considerations will take priority in the central bank's calculations.

Any capital outflows produced by Fed tightening would be manageable, though, he added, noting that the private sector's net overseas debt fell by 0.8 percentage point q/q as of the end of March and was 14.5 percentage points lower than in the second quarter of 2015, which saw a sharp movement of funds abroad.

RESILIENT YUAN

The yuan should be more resilient than most emerging-market currencies if the dollar strengthens, he said, noting that the PBOC's shift to a more flexible stance on the exchange rate has given it more room to adjust to market moves.

The central bank is expected to maintain a neutral policy stance, with a target for growth in M2 and total social financing to be in line with nominal GDP, noted Ding Meng, economist at Bank of China (Hong Kong), adding that the PBOC also increased injections at the end of June in response to seasonal liquidity tightness, before draining liquidity in subsequent days.

Both central and local governments could accelerate debt issues in H2, to support infrastructure investment, he said. The PBOC should not have to increase liquidity injections to help digest issuance since yields are low, with 10-year CGBs at 3.100%.

USDCNY should fluctuate from 6.34-6.88 against the dollar, weakening towards the end of the year, Ding said. The PBOC has indicated it wants to avoid any sharp appreciation of the yuan by recent moves including a hike in forex reserve ratios, and, according to Ding's model, has set weaker-than-expected fixings for the currency in recent days.

The yuan could fall to 6.8 if the dollar index rallies above 93, he said, adding that the CFETS basket of the currencies of 24 major trade partners could drop to 95 from its current high of 97.62 as China's advantage from its relatively quick recovery from Covid fades and as western economies normalise policy.