One of China’s top economists has highlighted the People’s Bank of China’s (PBOC) rising concern with foreign risk spillovers and domestic interest rate levels when it comes to the formulation and execution of monetary policy.
On 15 May, PBOC – being the Chinese central bank – released the “2023 Q1 China Monetary Policy Execution Report” (2023年第一季度中国货币政策执行报告) – a key source of signalling when it comes to its monetary policy intentions.
Wen Bin (温彬), chief economist at China Minsheng Bank, said the report marks at least a partial continuation of statements made at the Central Economic Work Conference held at the end of last year, the Politburo meeting at the end of April, as well as the regular monetary policy meeting that was held in the first quarter.
Changing conditions have led to adjustments to PBOC’s phrasing, with a heightened focus on foreign risk in the wake of US and EU banking sector problems, as well as declining interest rates that have squeezed net margins for Chinese lender.
“New conditions have led to some new statements and deployments, which have become the weathervane to guide financial support entities and influence market trends in the next phase,” Wen wrote in a recent opinion piece.
Wen highlight six key takeaways from the latest quarterly monetary policy execution report released by PBOC:
- The central bank’s overall assessment of domestic and foreign conditions is basically the same as the previous period. “PBOC is more concerned about other countries and generally optimistic about China itself. However, it is paying more attention to the constraints of overseas banking risk spillovers and insufficient domestic demand.”
- Assessment of price trends has changed significantly. “For the first time since last year, the expression ‘vigilance against future inflationary rebound pressure’ has been deleted. PBOC believes that domestic prices remain moderate in general, and there is no basis for long-term deflation or inflation, while the overall tone of monetary policy has also become stable.”
- Strengthening of quantitative policy guidance, focusing on “moderate total amounts and stable pacing”, avoiding large-scale “openings and closings”, and stabilizing market expectations. “Subsequent credit extension is expected to remain basically stable and moderately smooth out monthly fluctuations.”
- Structural policy will “focus on the key points, remain reasonable and moderate, and both advance and retreat. “Greater emphasis will be placed on promoting the use of phase-based tools during the implementation period, so that government investment can more effectively drive private investment.”
- The first mention of “maintaining a reasonable and moderate interest rate level.” “[PBOC] has stronger internal motivation to keep interest rates at a reasonable and moderate level. Room for downward adjustment of loan interest rates has narrowed, and deposit interest rates are expected to continue to decline.”
- Real estate policy remains forceful, upholding the two themes of “stabilizing real estate” and “expediting transformation”.
PBOC optimistic about domestic economy, concerned about overseas risk spillovers
While PBOC remains somewhat confident about the health of China’s domestic economy, its concerns about overseas spillover risks have increased in the wake of the Silicon Valley Bank collapse.
“With regard to the global economy, the central bank’s concerns continue unabated,” Wen writes. “In addition to high inflation, it is paying more attention to the spillover impacts of overseas banking risks and the uncertainty brought about by monetary policy. The long-term challenges brought about by accelerated changes in the international order are also becoming more prominent.”
Wen pointed in particular to concerns about overseas inflation and related contractionary impacts, following 10 consecutive hikes by the US Fed which have brought its target rate to the 5 – 5.25% level. PBOC is also concerned about the potential for rising interest rates to create a black swan event in the form of a regional banking crisis.
For this reason, Wen expects PBO to act moderately as well as step up regulatory scrutiny of the domestic banking sector, after drawing its own lessons from the Silicon Valley Bank collapse.
“The central bank will continue to pay attention to the development of overseas risks and monetary policy changes, respond flexibly in a forward-looking manner, and prevent the transmission of overseas risks to the domestic market,” Wen wrote.
“Prompted by events such as the Silicon Valley Bank collapse, the central bank’s monetary policy will avoid large-scale contraction and release, leave time for commercial banks to make adjustments, prevent them from being unable to adjust their balance sheets in a timely manner during the transition between loosening and tightening, and strengthen risk assessments such as stress testing and the preparation of response plans for various risk scenarios.
“In this context, the domestic banking industry should also pay more attention to risk prevention, optimize the structure of assets and liabilities, dynamically evaluate maturity mismatches, maintain sensitivity to the market, and further strengthen liquidity and interest rate risk management…PBOC will pay close attention to institutions with high interest rate sensitivity, high leverage, poor future cash flow, weak liquidity, and insufficient risk management to avoid potential counterparty risks.”
While PBOC is “confident overall” when it comes to China’s domestic economy, it remains concerned about problems that include high levels of youth unemployment and the difficulty of raising domestic consumption.
“The ‘scarring effect’ of the pandemic has not subsided,” Wen wrote. “Household income expectations are still recovering, young people are under greater employment pressure, and the sustainability of consumption recovery momentum is facing challenges.”
“At present, household savings are still at a high level, and the demand for large-scale consumption such as automobiles and home renovations remain weak. The unemployment rate of the population aged 16-24 rose further to 20.4% in April.
“The transformation of household excess savings into consumption is constrained by the differentiation of income distribution and unstable income expectations. The recent phenomenon of early repayment of loans by households has also affected current consumption to a significant extent, and the sustainability of consumption recovery remains to be seen.”
PBOC’s concerns about inflation recede
While the rest of the world continues to grapple with breakneck price gains, PBOC has become more supine in its attitude towards both inflation and deflation following a spate of weak CPI growth in China. Wen points out that these tepid price gains arrive despite a push from Beijing for accelerated credit extension.
“After the pandemic subsided abroad, the central bank continued to warn of rebound pressure for Chinese inflation in the future, and supported the establishment of domestic food and energy supply and price stabilization mechanisms,” Wen wrote.
“However, due to the impact of multiple factors including supply strength, household consumption habits, and differences in economic structure, there has been a divergence in domestic and foreign price trends. Since the start of this year, after the pandemic passed its peak, the finance sector has further increased its support for the real economy, and the fundamentals of the domestic economy have continued to recover.
“In the first quarter, credit and total social financing increased significantly, and the M2 money supply has also maintained a high growth rate of more than 12%. At the same time however, inflationary pressures have continued to decline. In April, Chinese CPI fell below 1% in year-on-year terms, while the PPI continued to post negative year-on-year growth, which also raised concerns about deflation.”
As a consequence, PBOC has made signal adjustments to the phrasing of its first quarter monetary policy report. It deleted the expression ‘”vigilance against future inflationary rebound pressure” and changed “closely monitoring changes in inflation trends” from the preceding report to “focusing on marginal changes in price trends.”
Wen argues that the reason for ongoing year-on-year CPI declines for China is strong supply capacity and slow demand recovery. He further contends that “there is no basis for deflation” given the ample state of China’s money supply and ongoing recovery in the economy.
Excessive credit creation in first quarter a potential source of problems
Despite its commitment to “prudent monetary policy that is precise and forceful,” Wen said the PBOC had driven robust growth in loans and the money supply in the first quarter that came in ahead of expectations.
This credit extension drive has failed to fully translate into accelerated recovery for the economy, however, and could potentially cause problems further down the road.
“Since the start of the year, growth in credit and total social financing have exceeded expectations for three consecutive months, with a recovery in real credit demand, efforts by banks to spur progress, the centralised deployment of early-stage credit loosening measures and the strong willingness of local governments to protect their economies,” Wen wrote.
“Renminbi loans increased by 10.6 trillion yuan, for an expansion of 2.27 trillion yuan compared to the same period last year. The scale of new credit in the first quarter is expected to exceed 40% of the annual figure, reaching the peak of credit for the year.
“However, in the first quarter the stimulatory effect of the high volume of credit and total social financing on economic growth and inflation fell short of expectations by a considerable extent.
“In April, economic data slowed down in month-on-month terms and the inflation data was weak. The scissors gap between the M2 growth rate and nominal GDP growth rate and the scissors gap between the M2 growth rate and M1 growth rate is still large, reflecting the fact that the banking system was still in a state of insufficient finance demand.”
Wen said that this concerted drive to accelerated credit extension could create problems for the Chinese economy in future, and will prompt tightening by PBOC.
“A large number of low-interest loans may exceed the actual demand from enterprises for investment and business activities, and some funds are being used for repayments, remaining within the financial system,” he wrote. “There is definite room for idle arbitrage.
“In the future, if we continue to increase monetary easing, it may exacerbate the imbalance between credit supply and demand, bring about a further decline in loan pricing, and exacerbate arbitrage behaviour at the micro-level and potential risks at the macro level.
“In order to avoid ‘flooding’ caused by the strong growth of credit, prevent funds from lying idle, and improve the efficiency of fund usage, the total amount and pace of credit issuance will be effectively controlled with the theme of ‘moderate total amounts and stable pace’… in the second quarter, the growth of bank credit will slow down.”
Interest rates emerge as fresh concern for PBOC
Wen points out that PBOC has expressed renewed concern over interest rate levels following a narrowing of net interest margins that has prompted a push for reductions to deposit rates. The volume of loans with rates beneath the benchmark loan prime rate (LPR) has also seen an increase.
The first quarter monetary execution report made debut use of the phrase “maintaining a reasonable and moderate interest rate level” (保持利率水平合理适度), while also calling for “promoting the steady decline of corporate financing costs and personal consumption credit costs” – a statement that was also made at the first quarter monetary policy meeting in April.
According to Wen, the use of these terms “clearly shows that the central bank has an overall concern with pushing loan rates to continue to decline, as well as an endogenous motivation to keep interest rates at reasonable levels.”
“At present there is little need for further declines in interest rates and the room for this has contracted significantly.”
Wen points out that a sizeable percentage of Chinese loans now have rates beneath the benchmark LPR.
“Since the beginning of the year, with credit competition and increased real support, the proportion of loans with interest rates lower than the LPR has further increased,” Wen writes.
“According to the data from the central bank, the proportion of loans with an interest rate higher than the LPR out of general loans in March was 56.16%, the proportion of loans with an interest rate equal to the LPR was 6.88%, and the proportion of loans with an interest rate lower than the LPR was 36.96%.
“For this reason, it has become an important task for the central bank to protect the bottom area of the loan interest rate level, guide the reduction of bank liability costs, and protect the net interest margins of commercial banks.
“For a period of time to come, interest rates on new ordinary loans and corporate loans may stabilize at around 4.50% and 4%, and the rate of further declines is not expected to be too large.”
Structural tools to focus on financial inclusion and green finance
Wen expects the structural tools that have become a mainstay of Chinese monetary policy since the Covid pandemic to maintain their focus on financial inclusion and green finance.
“In terms of the direction of structural tools, the monetary policy execution report for the first quarter continued the previous quarter’s statement of ‘focusing on key points, being reasonable and moderate, and advancing and retreating,'” Wen wrote.
“It also emphasized maintaining the stability of re-lending and re-discounting tools, and making effective use of phase-based tools to provide strong support for key areas and weak links such as financial inclusion, technological innovation, and green development.”