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PBOC governor's boast of having 'tremendous room' to act to be tested soon
THE boast by People's Bank of China (PBOC) governor Yi Gang this month that he has "tremendous room" to adjust policy could soon be tested as the economy slows, shifting attention to the impact on the nation's fragile currency and financial markets.
Compared to European and Japanese peers, China does have more obvious policy space. Its benchmark one-year lending rate has stayed at 4.35 per cent since 2015, far above zero. The Federal Reserve's dovish turn also eases the depreciation pressures on the yuan, leaving Mr Yi even more room to manoeuvre.
Mr Yi may be looking at his toolkit more carefully after data released on Friday showed industrial output growth in May slowed to the weakest pace since 2002, highlighting headwinds from the trade war with the US. Production slowed across the board even as solid readings for property investment and retail sales suggest some measures to cushion the slowdown are filtering through.
"Policymakers always have room but they need to ask themselves 'at what cost?' " said Rob Subbaraman, head of emerging markets economics at Nomura Holdings Inc in Singapore. "Easing monetary policy aggressively could come at the cost of a yuan depreciation overshoot or another debt-fuelled property market bubble." The government and central bank have already unveiled various targeted measures to boost infrastructure spending, support credit growth, cut taxes and increase consumption even while avoiding massive stimulus measures as in previous downturns.
Here are the key options Mr Yi and policymakers will consider should they need to respond more aggressively:
Some economists predict that a worsening trade war and job-market outlook could prompt the central bank to take bolder easing steps, such as cutting the benchmark rate that governs a broad range of lending across the economy, including mortgages.
As tariffs dampen growth and confidence, economists at Bank of America Merrill Lynch and Bloomberg Economics see reductions of as much as 50 basis points this year.
A cut would likely send the yuan plunging though, testing Mr Yi's recent statement that no "one number" on the exchange rate is more important than any other.
Beyond the benchmark rate, the central bank could also steer banks' short-term borrowing costs lower, a move posing a lower risk of currency depreciation.
The amount of funds that the PBOC requires banks to park as reserves is a legacy of an era of massive capital inflows.
Nevertheless, it's still at an elevated 13.5 per cent for major banks after being reduced via universal or targeted cuts from 16 per cent a year ago, steps that released billions of yuan of liquidity to the financial system. That space means Mr Yi is likely to turn to this tool before cutting rates.
As authorities look to keep the credit taps flowing, Morgan Stanley, China International Capital Corp and Macquarie Securities Ltd expect further cuts to the proportion of deposits banks are forced to lock away. Bloomberg Economist David Qu estimates another 1.5-2 percentage points of reserve requirement cuts by year-end while a Bloomberg survey in May sees 100 basis points in cuts.
Reserve cuts are no panacea, though. Policymakers have repeatedly warned against flooding the financial system with cash, wary of the emergence of bubbles in the property sector and risky lending elsewhere.
Small-scale cuts targeted at small businesses or rural borrowers have less broad-based impact, while across-the-board reductions bear a similar risk of yuan fragility.
"The market consensus on China's monetary policy remains focused on targeted easing. Based on conditions facing the People's Bank of China right now, that makes sense," said David Qu and Tom Orlik at Bloomberg Economics.
"Based on conditions they will likely face in the second half of the year, it does not. We anticipate two rate cuts as an intensifying trade war hits already-fragile growth."
Whatever levers China pulls in response to a slowdown, it must calibrate the impact it will have on the yuan. Mr Yi hinted that the level of 7-per-dollar is not a line in the sand and Goldman Sachs Group Inc expects the yuan to breach 7 within the next three months, as its decline could be a natural offset to higher US tariffs, strategists including New York-based Zach Pandl wrote in a note.
"China can do whatever it takes to backstop growth," said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. "They just can't do that and expect to maintain currency stability."
Finally, what about fiscal policy?
China still has a fiscal war chest of about US$3.65 trillion to counter any further fallout from the trade war, according to an analysis by Bloomberg of government spending last month. Central and local authorities had at least US$3.65 trillion unspent in their budgets this year, data compiled using official budget plans showed. That's two trillion yuan more than the ammunition China had in the same period last year. BLOOMBERG