The latest salvo by China’s policymakers to stimulate the nation’s slowing economy may well provide a short-term boost but is unlikely to be the panacea markets are hoping for, experts claim.
Early February saw the People’s Bank of China (PBoC) slash the reserve requirement ratio (RRR) for commercial banks by 50 basis points, taking it to 19.5 per cent for the vast majority of institutions. Some smaller banks will receive an additional 0.5 per cent cut.
The strategy – essentially a form of light quantitative easing – raises banks’ lending capacity by allowing them to hold less cash in reserve, thus freeing up their ability to provide credit to businesses and individuals.
The move follows the Bank’s surprise decision in November to slash its benchmark-lending rate by 40 basis points to 5.6 per cent and its deposit rate by 25 basis points to 2.75 per cent. The PBoC also lowered the RRR for selected banks in 2014 but its latest action represents the first cut in this cycle to apply across the board.
Research hub Capital Economics estimates this month’s move is equivalent to a monetary injection onto banks’ balance sheets of some $96bn (£63bn). But, as Kathleen Brooks, a research director at Forex.com, points out, given the Chinese economy is worth $10trn, the cut is a mere “drop in the ocean”.
The world’s second largest economy achieved GDP growth of 7.4 per cent in 2014, surpassing the majority of expectations, but it still represented the lowest reading in almost a quarter of a century.
But in spite of the Bank’s efforts, the outlook for growth remains stilted in 2015.
Nitesh Shah, associate director research at ETF Securities, says: “Both the World Bank and International Monetary Fund have downgraded their 2015 China growth forecasts to below 7 per cent.
“The message from policymakers in China is that sub-7 per cent growth is acceptable, so long as its reform agenda continues apace.”
These reforms aim to make China’s economy more reliant on consumption rather than high investment.
Mark Williams, chief Asia economist at Capital Economics, believes the consequence of the PBoC’s latest move will be minor but the fact the RRR cut was announced at all and that it applies to all banks, is in itself significant.
“In practice, the RRR is only one of the constraints that banks operate under,” he says.
“For smaller banks in particular, the loan-to-deposit ratio is the chief bar to increased lending. Banks also have to adhere to loan quotas set by the PBoC. As a result, the direct impact of the move on lending will be small.”
Anna Stupnytska, global economist at Fidelity, feels that while the PBoC’s announcement is good news for China’s short-term growth, it could also mean bad news for its longer-term sustainability.
“The action is likely to undermine efforts over the past year to reign in credit, as lower rates will continue to fuel China’s domestic debt,” she predicted.
“However, banks, businesses and consumers all know that tightening must lie ahead at some point, so the lending channel transmission is unlikely to be as efficient as before. This means the growth benefits from this move are unlikely to be very meaningful.”
Given the European Central Bank announced a quantitative easing strategy worth more than a trillion euros, while the central banks of Canada, Switzerland and Denmark have all also engaged in monetary loosening policies recently, the PBoC’s actions have been notable by their absence.
Ms Brooks believes China’s 2014 GDP growth, coupled with the contraction of its manufacturing purchasing managers’ indices for January, has spurred the Bank to take action.
She says: “If China wants to boost growth for the rest of the year, the PBoC had to play catch-up by loosening monetary policy sooner rather than later.”
But given the economic backdrop, with consumer price inflation falling to 1.5 per cent at the end of 2014 from 2.5 per cent a year earlier, and property prices continuing to fall, Mr Shah expects the PBoC to cut interest rates further this year.
Ms Brooks anticipates the PBoC may use the RRR as its preferred policy tool this year, given that it still stands at a hefty 19.5 per cent, meaning there is room for further cuts.
For his part, Mr Williams is forecasting, alongside three further RRR cuts in the course of 2015, a further cut to benchmark interest rates, “perhaps twice more by the middle of this year”.
He says: “As for the impact on China’s economic growth, we don’t expect it to be large. We still expect a further GDP growth slowdown in 2015. But downside risks are mitigated by the PBoC’s evident willingness to respond as signs of weakness emerge.”
M&G Investments’ emerging markets fund manager Matthew Vaight suggests in spite of the economic challenges China faces, ample investment opportunities remain, especially given that “plenty of companies are priced with a crisis in mind”.
“We believe there will be opportunities arising from the fact China’s economy is in transition,” he claims.
“The old model relied on low-cost manufacturing, but China is no longer a cheap place to manufacture as rising wages are eroding its competitiveness.
“By focusing on innovation and quality, Chinese firms can become globally competitive.”
