Short Insight – China’s cautious tightening approach

by: Arjen van Dijkhuizen

  • China’s targeted monetary tightening / financial deleveraging still continues …
  • … while fiscal stimulus is being withdrawn as the economy proves resilient
  • However, Beijing still committed to prevent ‘overtightening’ …
  • … and prepared to soften its approach should downward pressures (e.g. from trade tensions) rise
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1. Cautious monetary tightening ongoing, but no ‘overtightening’

Beijing’s targeted tightening campaign is still ongoing, fitting within the broader strategy to reduce systemic risks (a.o. from shadow banking). As in 2017, the PBoC has continued with mini hikes of policy rates for its open market operations and lending facilities, pushing money market rates higher. In the past months, rates for 7, 14 and 28 day reverse repo operations were raised by 5 bps (to  2.55%, 2.7% and 2.85%, respect-tively). Meanwhile, the central bank has kept the benchmark 1-year lending rate unchanged at 4.35% since October 2015, as it does not want to aggressively tighten its monetary stance.

However, the authorities have now and then softened their approach to prevent ‘overtightening’ by supporting overall liquidity and easing the pain for certain hard hit segments of the financial sector. For instance, on 25 April the PBoC cut the reserve requirement ratio by 100 bps, lowering funding costs for banks. Moreover, the PBoC recently expanded its collateral requirements regarding its Medium Term Lending Facility, enhancing access for financial institutions with high SME exposures.

2. Lending slows marginally, financial conditions tighten a bit

The gradual tightening of the monetary stance is indeed also reflected in Bloomberg’s Monetary Conditions Index (based on real interest rates, total loan growth and the real effective exchange rate). This index shows a gradual tightening during 2017, becoming even more visible in the first four months of this year (partly explained by REER appreciation). Lending growth is coming down, although more or less stabilising since 2017.

A similar pattern (tightening, but softening again if needed) is visible with regard to macroprudential regulation. Federal and local authorities have continued with tightening rules regarding e.g. housing (finance), local government (debt), asset management practices and liquidity management. However, recently implemented guidelines for asset management and liquidity risks have come in softer than the initial draft had suggested.

3. Fiscal accommodation removed, as economy is resilient enough

Fiscal data on China are a bit shady, very seasonally driven and not always easy to interpret. The chart to the right is derived from Bloomberg data on total fiscal expenditure (fiscal revenue data are not up to date). The chart suggest that fiscal spending growth has slowed in the course of 2017 and picked up again at the start of 2018. That resulted for instance in some analysts stating that the government was stepping up fiscal stimulus to prop-up growth.

However, this chart also shows that fiscal spending in yoy terms slowed again in recent months. A possible explanation for the pick-up of fiscal spending growth in early 2018 is that land sales have remained very buoyant, creating more space for local governments (who are more and more controlled and under more regulation) to spend.

Other signals pointing to a tightening of the fiscal stance come from the series for investment by state related entities and for infrastructure spending. Both indicators tend to pick-up at times the government uses fiscal stimulus to support growth. Annual growth of state-led investment and infrastructure spending has continued to slow since mid-2016 and early 2017, respectively.

4. Beijing to change course in case of too strong downward pressure

All in all, also taking into account a tighter approach towards local governments – fiscal accommodation has been reduced in the past year or so. That stems partly from the fact that the economy (supported by robust consumption and a pick-up in private investment growth and strong external demand) is resilient enough by itself. In March during the annual NPC, Beijing lowered the official budget deficit target – for the first time in six years – from 3.0% of GDP to 2.6%, pointing to a tighter fiscal stance as well. Still, the effect of that move will be limited, as policy makers made clear at the same time that the lowering of the formal budget deficit was offset by higher off-balance sheet spending.

That said (as with monetary policy), the government could well start considering using fiscal stimulus again should downward pressures on growth (for instance stemming from an intensification of trade and investment skirmishes with the US) rise to an extent that is deemed intolerable.