China needs more than monetary stimulus to bolster flagging economy: analysts
CHINA’S central bank turned to rate cuts in June to bolster a fading economic recovery, reducing businesses’ and households’ borrowing costs. But with a slew of poor data in the past two months, monetary stimulus alone will not be able to shore up the faltering economy, analysts said.
Last month, the People’s Bank of China (PBOC) cut several key policy rates – namely the seven-day reverse repo rate, the one-year medium-term lending facility (MLF) rate, as well as the overnight, seven-day and one-month standing lending facility rates – by 10 basis points each.
The country’s major commercial lenders followed the central bank by slashing their benchmark lending rates on Jun 20, bringing the one-year and five-year-plus national loan prime rates (LPRs) down by 10 basis points each. Both rates affect borrowing costs in the real economy, with the five-year-plus rate being a reference for mortgages.
The PBOC’s rate cuts suggest Chinese policymakers are becoming increasingly concerned about a recovery that is losing steam and see a need for more monetary easing to lift market expectations, some analysts said.
But others see the impact of the rate cuts being limited, having little sway on demand in the real economy.
The policy rate cuts came before a slew of official data showed economic activity had weakened in May, after having staged a comeback in the first quarter following China’s scrapping of Covid-19 controls.
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The National Bureau of Statistics data published on Jun 15 showed that in May, growth in consumption and fixed-asset investment slowed, the property sector failed to emerge from a long slump, and youth unemployment hit a record high.
The policy rate cuts aimed to boost expectations and signal Beijing’s effort to stabilise growth, said Zhong Linnan, a senior macro analyst at GF Securities.
Some analysts question the link between interest rates and China’s poor economic performance.
“The country’s sluggish economy is not a result of high interest rates, but rather, constrained infrastructure and real estate investment,” wrote Xu Gao, chief economist at BOC International (China) in a June commentary.
Property developers and local government financing vehicles (LGFVs) – which typically fund infrastructure investment – account for much of the financing in the real economy, but their demand has shrunk dramatically in recent years as Beijing stepped up efforts to curb speculation and excessive debt.
“With the financing of both developers and LGFVs so constrained, China’s real economy is now way less sensitive to interest-rate changes,” wrote Xu. “Therefore, cutting rates alone is no solution to the economic slowdown.”
As the transmission of monetary policy is blocked, the rate cuts may neither rev up credit demand nor stimulate investment, he added.
Currently, a large amount of funds that are supposed to be pumped into the real economy are flowing back to the financial system, analysts at BOC International wrote in a June note, citing elevated liquidity levels in the interbank market.
But the cuts helped repair distortions in China’s rate system, where some benchmark rates had dipped below policy rates, meaning interbank borrowing costs had been lower than borrowing from the central bank.
Policy flaws
Rate reductions also have flaws. Multiple rounds of LPR and MLF rate cuts since 2020 have squeezed the margins of banks. As a result, they have reduced deposit rates in recent months to maintain profitability, although some adjustments have been relatively small.
“Small and mid-size banks won’t be able to maintain stable operations if their margins are overly squeezed, and they will become more prone to financial risks. This in turn may take a toll on the real economy,” said Zeng Gang, director of the Shanghai Institution for Finance and Development.
Another market concern is that the widening gap between global and Chinese rates could fuel capital outflows from China and heap short-term pressure on the yuan, as central banks elsewhere, including the US Federal Reserve, tightened monetary policy in recent months. In June, both the onshore and offshore yuan breached the closely watched 7.2-per-US-dollar level.
However, some analysts are not ruling out the possibility of more rate reductions this year, as the PBOC puts a greater emphasis on financial stability. As the Fed held off its aggressive rate hikes in June, Chinese policymakers now have more room for monetary loosening, they said.
Debt costs are just one factor weighing on financing, investment and consumption in the real economy.
The policy rate cuts may be the starting point for a new round of stimulus aimed at stabilising growth, which may include policies targeted at key sectors including property, analysts said. CAIXIN GLOBAL
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