China: from monetary to fiscal policy

Market analysis - 9/16/2016

The People’s Bank of China is shifting from monetary policy tools to fiscal measures.

At the start of 2016, the Chinese government embarked on an intense policy to support GDP growth through increased infrastructure spending. So far this year, the People’s Bank of China (PBoC) has shifted away from the monetary policy tools – including prime interest rates and banks’ reserve requirement ratios – that it had used so many times in 2015 (see left-hand chart below). The Chinese authorities now prefer to pull other levers. This is clearly seen in the scope of the credit-based stimulus enacted in Q1, which amounted to 40% of GDP. This approach derives from the structure of the world's second-largest economy, which differs in many ways from developed economies.

Since the end of 2015, Beijing has tended to refrain from systematically cutting rates as a way to spur economic activity. It wants to avoid putting downward pressure on the yuan – although with USD 3.201 trillion in currency reserves it could certainly prop it up – and prevent valuation bubbles on certain assets, especially in the property sector.


Historically, one side effect of interest-rate cuts has been to push down mortgage interest rates and spark demand for property (see right-hand chart on the previous page). Property is particularly attractive for investment and diversification purposes in an economy where alternatives to saving are few and far between. Yet property markets differ widely from region to region, which means that an interest-rate cut will not have the same impact all across the country. Coastal provinces, which are faster-growing and have a higher population, will see a rapid and steep rise in property prices. Northern provinces, which are more industrial and thus harder hit by a slowdown in manufacturing activity, will remain depressed by a housing glut following years of overinvestment.

The cycle of cuts in the prime-lending rate that began in 2015 is clear proof of this: the price of newly built homes in the main cities climbed by 20% year on year while the average price remained stable (+0.2%).

The Chinese authorities are now focused on more targeted measures that take these regional disparities into account. Recently, property markets in some regions have been overheating, leading the government to introduce targeted restrictions rather than tightening access to credit by raising prime rates. Examples of targeted measures include limits on the ability to purchase secondary residences and higher downpayment requirements.

A move to expand regulation of the shadow-banking system is driven by a similar mindset. In this case too, recent history shows that a more accommodative interest-rate policy tends to overinflate the mass of credit in the economy through these informal and relatively unregulated channels. Here too, targeted measures like stricter oversight of wealth management products – products that offer high returns, that are often designed to finance sectors hobbled by limited credit, and that have an estimated value of CNY 23.5 trillion – are aimed at gaining more control over shadow-banking activities and, more broadly, the country’s debt.

So rather than attempting to influence economic activity through a policy of hard-to-manage rate cuts, Beijing is focusing on stimulating economic activity through credit while at the same time controlling the level of liquidity in the financial system through a number of specific instruments (see table below).

 We expect this overall approach to remain in place for the coming months. China will inject credit on occasion in order to meet its full-year growth target of +6.5%, while drawing on its arsenal of measures to manage liquidity in the economy. The large number of tools at the government’s disposal makes it difficult to clearly identify the impact of its measures. That said, the property-market and shadow-banking examples discussed above suggest a relatively unaccommodating or even restrictive attitude. This trend is apparent in credit growth, which contracted from +12.5% in March to +10.9% in July.

Still, Beijing looks set to continue supporting GDP growth through fiscal measures. The official target of a public deficit equal to 3% of GDP in 2016 will probably have to be raised, as it was in 2015.

We can take comfort in the fact that the authorities are framing their actions more carefully and measuring out their support for the economy. But this also means that Chinese GDP growth is unlikely to deliver any surprises to the upside. We still expect Chinese GDP growth to decelerate in 2016-2017. While steps have been taken to reduce the production capacity of state-owned enterprises, broader government measures should focus on private consumption. The ultimate success of China’s economic transition will be measured against that variable.


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