Chinese Monetary Policy to Turn Conservative in H2 2023 as Debt-GDP Ratios Rise: Guan Tao


One of China’s leading economists forecasts restraint in the exercise of monetary policy tools in the second half of 2023 despite tepid inflation levels, as the Chinese economy stages a recovery yet debt levels rise.

Guan Tao (管涛), chief global economist for Bank of China International, wrote in a recent opinion piece that China’s policymakers have signalled the maintenance of “prudent monetary policy” after economic and financial data since the start of the year pointed to a robust recovery from the Covid pandemic.

Debt levels have become a more pressing concern following Covid-era stimulus measures, however, while policymakers have also fretted about the possibility of a rise in inflation.

For these reasons, Guan expects that in the second half of 2023 Chinese monetary policy will exercise “marginal restraint,” while still maintaining the overall theme of ensuring economic stability.

Rising debt and tepid consumption remain key concerns

Guan gave a positive overall assessment to Chinese monetary and macro-economic policy during the Covid pandemic, particularly compared to the central banks of advanced economies that are currently wracked by breakneck inflation.

“China’s macroeconomic policies have maintained restraint during the three years of the pandemic,” Guan writes. “The Chinese model has not allowed inflation to get out of control.

“Although major central banks overseas continue to shift the responsibility for inflation onto supply-side factors such as broken supply chains, geopolitical conflicts, and labour shortages, it is an indisputable fact that overstimulation has overheated demand and inflation has exploded.

“[This] has completely shattered the fig leaf of Modern Monetary Theory (MMT). The central banks of most developed economies now need to tighten aggressively, succumbing to the ‘trilemma’ of stabilizing prices, stabilizing growth (employment) and stabilizing finance.”

Guan nonetheless said Chinese policymakers had cause for concern with regard to gains in debt levels caused by Covid-era stimulus measures.

“Although [China] has not implemented negative interest rates, quantitative easing, or deficit monetization operations, from the perspective of certain quantitative indicators, China’s policy response to this public health crisis has been no weaker than that of the major developed economies,” Guan wrote.

Guan points out that China has seen accelerating growth in the ratio of general government debt to GDP compared to other major economies towards the end of the Covid pandemic.

In 2020, the ratio of general government debt to GDP in developed economies rose by an average of 18.9 percentage points, while in the US it surged 24.8 percentage points. In sharp contrast, for China the increase was only 9.7 percentage points.

As of the end of 2022, however, the average government debt ratio in developed economies had increased increased by 8.4 percentage points compared with 2019, while in the US the increase was 12.9 percentage points. China surged ahead these readings, with an increase of 16.7 percentage points.

Guan further points out that this rising debt has yet to abate since the start of the 2023.

“According to some estimates, by the end of the first quarter of 2023, the macro-leverage ratio of China’s real economy sector may increase by 8.8 percentage points from the previous quarter.”

In addition to an increase in key debt ratios, China’s macro-economic response to the Covid pandemic has also impeded consumption growth – long considered one of the key weak points of the Chinese economy.

“China’s macro-policy is mainly directed at the protection of market players on the supply side and focusing on liquidity support, while developed economies led by the US directly stimulate final demand and focus on improving solvency,” Guan wrote.

“As a consequence, in the three years since the epidemic started, Chinese consumption has recovered slowly, while its growth rate has been significantly lower than its level for the three years before the epidemic. At the same time, the nominal consumption growth rate of developed economies has soared on the back of high inflation.”

According to Guan, long-standing dependence on investment as a driver of GDP growth and comparatively weak levels of consumption remain a key problem for the Chinese economy.

“Reliance on investment to drive employment, increase labor income and promote consumption has a long transmission chain, and it is difficult to rapidly make up for the ‘gap’ of income decline,” Guan wrote.

“On the other hand, household consumption is the income of enterprises, and private enterprises that are more endogenous in nature will be more cautious about investment and job creation when they see weak growth in consumption.

“Insufficient aggregate demand and damage to balance sheets uninder the guise of low inflation are the ‘scarring effects’ that China has to face, which is related to the progress and quality of China’s economic recovery after the epidemic.”

Active monetary policy helps to drive robust Covid recovery

Official data since the start of the year points to a robust recovery in the Chinese economy following the lifting of Covid-related movement restrictions. According to Guan, active monetary policy has played a key role in this process by driving accelerated growth in credit.

“Since 2023, financial data has repeatedly exceeded expectations,” Guan wrote.

As of the end of March, China’s M2 money supply had increased by 12.7% in year-on-year (YoY) terms, for its highest growth rate since May 2016. Outstanding total social financing (TSF) increased by 10%, for an acceleration of 0.4 percentage points from the end of 2022.

In the first quarter new renminbi loans reached 10.6 trillion yuan, for an increase of 2.3 trillion yuan compared to the same period last year and the largest increase on record.

According to Guan the People’s Central Bank (PBOC), being the Chinese central bank, has played an active role in driving credit growth since the start of 2023, as part of broader efforts to spur economic recovery.

On 17 March PBOC reduced the reserve requirement ratio (RRR) in a bid to stabilise growth, while in the first quarter the balance of its structured monetary policy tools saw an increase of 375.4 billion yuan, primarily due to the use of carbon reduction support tools, special re-loans to support clean and efficient coal usage, and re-loans for tech innovation. These three instruments collectively accounted for 71% of the first quarter increased the structured monetary policy tool balance.

PBOC’s deployment of these instruments has helped the Chinese economy to achieve a robust recovery from the reimposition of strict Covid-related lockdown measures last year.

In the first quarter of 2023 the Chinese economy achieved real growth of 4.5% – handily beating the 4.0% consensus forecast of domestic analysts.

Investment remains a key driver for the stabilisation of domestic demand, with capital formation making a 34.7% contribution to economic growth in the quarter.

Fixed asset investment increased 5.1% YoY in the first quarter, matching the growth rate for 2022, while infrastructure investment increased by 10.8%, for decrease of 0.7 percentage points compared with full year 2022. The property sector remains especially tepid in the wake of last year’s debt woes, with real estate investment falling 5.8% YoY.

While Guan points the weaknesses created by over-dependence on investment and weak consumption, China’s consumer and services sectors have staged a rally since the start of 2023. In the first quarter, the contribution rate of final consumption expenditures to economic growth is expected to have reached 66.6%.

Chinese monetary policy expected to remain conservative

Given robust recovery from the pandemic and a moderate inflation level of just 2% in 2022, Guan Tao expects PBOC to remain both cautious and conservative in its implementation of monetary policy in the second half of 2023, particularly given recent signals from top policymakers.

“A politburo meeting in April proposed that a proactive fiscal policy should be strengthened to improve efficiency, and a prudent monetary policy should be precise and powerful, in order to form a joint force for the expansion of demand,” Guan writes.

“In the second half of the year, monetary policy will be marginally constrained, but the main theme of stabilisation will remain unchanged.

“It is expected that monetary policy in the second half of the year will show moderation in the aggregate, with targeted structural tools as the mainstay, and perhaps also restrained use of phase-based tools.”

“The next step is to focus on follow-up arrangements for structural tools that have already expired or are about to expire this year, as well as innovative structural tools that target new key areas and weak links.”

Guan said there will be “no big moves in monetary stimulus,” particularly given adverse developments in other major economies as a result of botched monetary policy decisions during the course of the pandemic.

“After witnessing the financial turmoil caused by the extreme easing of the central banks of major economies that has since shifted to extreme tightening, China’s monetary policy won’t see any ‘flooding,'” Guan wrote. “Moreover, monetary policy is ultimately a debt instrument that can only solve liquidity problems.”

Contrary to general market expectations, Guan does not expect PBOC to cut interest rates before the end of 2023.

“The rate cuts expected by the market may not be realized in the second half of the year,” Guan wrote.

“According to [PBOC governor] Yi Gang, China’s monetary policy remains relatively conservative, and the real interest rate will be set slightly lower than the potential growth rate.

“The market still expects interest rate cuts within this year, mainly due to expectations of a potential decline in economic growth and weak inflation.

“When necessary, however, RRR cuts may be an optional aggregate tool that takes precedence over interest rate cuts.”