#dnaEdit: China’s monetary easing

With a sudden cut in its reserve requirement, the People’s Bank of China (PBoC) has joined many of the world’s leading central banks in introducing a more accommodating monetary policy regime to boost the growth process. The PBoC has slashed its reserve requirement by 50 basis points. This will release some 650 billion yuan (roughly around $100 billion) into China’s financial system. Big as China’s economy is, any such move by the PBoC will create a ripple effect. Experts are decoding the policy in different ways.

Apparently, this has been done after China’s economy showed signs of slowing down. China’s quarterly GDP growth was lower than the target by a small margin. And this has prompted the question whether the country was hence going to be in a slowdown mode. At its highest, China had grown by close to 11% per annum and the latest figures show China’s economy expanding by around 7%. Chinese authorities have of course been saying that the hectic growth phase would have to be tempered to more manageable levels. Some slowing down therefore was indeed welcome. However, the fear is of the slowdown becoming secular and decelerating faster.

One indicator — the widely quoted HSBC bank’s purchase managers’ index (PMI) — is showing that China’s industrial sector is contracting. Additionally, imports have been sluggish for the greater part of last year which suggests a slowing down of the industrial sector.

The most important factor here is the lack of growth of domestic consumption. China has recently been trying to restructure its economy —switching from the current export-led model to domestic-consumption-led model. Therefore, the Chinese authorities are giving incentives to boost consumption among the resident Chinese population. Earlier, the Chinese economy was mainly based on exports and making huge investments in its infrastructure sector. 

But that strategy has now boomeranged. China has created massive production capacity much in excess of its domestic demand. For example, at around 600 million tonnes a year, China has the world’s largest steel production capacity. But the country cannot consume more than 300 million tonnes — and that too with artificial props. Efforts are, therefore, underway to export and dump steel abroad. India, for example, has complained of dumping by China.

In view of the lukewarm growth in domestic consumption and fall in industrial performance, Chinese inflation has also been too low. The monetary authorities are apprehensive of having to tackle deflation — like in Japan. Deflation is difficult to surmount. Currently, China’s inflation level is just about 1%, sometimes even lower than that. If China gets into a falling price syndrome, its economy might end up like the Japanese economy, which stagnated for a decade because of falling prices. 

Over the past six months, the number of items that have decreased their prices has significantly risen. China has a system of monitoring prices of some 50 products used widely by the industry. Their prices are compared over a 10-day cycle. Late June 2014, the prices of nearly 23 out of the 50 products declined as compared to the previous 10 days. More recently, between January 1st and 10th, the prices of 38 of the monitored products declined.  This signals that deflationary pressures are increasing in China.

In this context, the PBoC, has now pushed more funds into the banks by lowering their own cash reserve requirements. The fresh infusion of some 650 billion yuan is hoped to result in higher bank loans thereby making investments and consumption easier. 

Experts, however, observe that in the absence of real investment on the ground, it is difficult for banks to lend this extra amount for productive purposes. What might happen is the funds could end up in asset purchases. The stockmarket, therefore, could rise.