Speculation has emerged since the start of April that Beijing could launch its own round of quantitative easing or even MMT-based debt monetisation, following reports that the People’s Bank of China (PBOC) is planning to increase treasury purchases, as well as recent statements from Xi Jinping on the need to expand monetary policy tools.
“In recent days, the market has seen increased discussions of the central bank’s gradual increase of treasuries purchased via open market operations, with some viewpoints even interpreting this as the preparatory phase for the Chinese central bank to launch quantitative easing,” said Ming Ming (明明), chief economist for CITIC securities, to STCN in an article published on 3 April.
“Rumours have circulated that the central bank will gradually increase trading of treasuries, and that purchase of treasuries on the primary market wil lead to the central bank directly injecting base money into the economy, which will trigger extreme loosening of liquidity and interest rate declines,” wrote Ran Xuedong (冉学东) for the National Research Network in an opinion piece published on the same date.
“This would have a huge impact on asset prices, similar to the QE implemented in recent years by the central banks of Europe, North America and Japan.
“Consequently it’s triggered speculation on the market, as to whether or not China’s monetary policy will see the implementation of policies similar to QE.”
The speculation arrives amidst renewed focus on recent remarks by Xi Jinping on the need for changes to Chinese monetary policy.
At the Central Financial Work Meeting held in October 2023, President Xi Jinping highlighted the need for “expanding the monetary policy tool kit, and the central bank’s open market operations gradually increasing treasury transactions.”
The remarks were recently reprinted in a book released by a publishing division of Community Party of China (CPC) entitled “A Summary of Xi Jinping’s Discourse on Financial Work” (习近平关于金融工作论述摘编).
The statement has triggered much discussion in China’s financial circles, given that Beijing is currently grappling with a slew of economic challenges in 2024 that have prompted expectations of greater fiscal and economic loosening in the year ahead. These challenges include lacklustre domestic demand, an ailing housing market, regional debt risk and heightened geopolitical tensions with major trading partners.
In addition to speculation of quantitative easing, some domestic observers have even reached the conclusion that China could engage in debt or deficit monetisation based on the principles of Modern Monetary Theory (MMT), in order to help deal with the copious debt pressures of local government created by prevailing fiscal arrangements.
Do increased treasury purchases signal plans for Chinese-style QE?
Wen Bin (温彬), chief economist at China Minsheng Bank, points out that QE and MMT policy both essentially involve “the injection of large volumes of liquidity via the purchase of financial assets to achieve a rapid expansion in [the central bank] balance sheet.”
“For this reason, reports of plans by PBOC to step up treasury purchases in tandem with China’s current economic challenges have driven speculation that QE or debt monetisation are potential policy option for Beijing.”
According to Ming Ming, however, PBOC’s current increases in treasury purchases do not constitute preparations for QE or MMT-driven deficit monetisation, but are just part and parcel of regular open market operations by the central bank to loosen up liquidity.
“Bond purchases by the central bank are not the same as QE,” Ming said. “QE refers to the adoption of unusual monetary policy by the central bank when benchmark rates are at or close to zero.”
“In China, the rates for medium-term lending facilities (MLF) currently range between 2.5% to 3.3%, and we are still at some distance from zero interest rates.”
Wen also considers ongoing shifts in treasury purchases by PBOC to be part of standard procedure for its monetary policy operations.
“Even if the central bank buys treasuries, the policy arrangements and rationale differ from QE or fiscal deficit monetisation,” Wen said.
“It’s a standard monetary policy tool for adjusting long-term liquidity, which differs from Western-style quantitive easing,
“PBOC’s execution of monetary policy is achieved by the purchase and sale of treasuries, other government bonds, financial bonds and forex, The central bank uses these methods to provide short-term funds to the market, thus achieving its monetary policy targets.”
Wen Bin further makes the point that China is in the midst of a deleveraging drive with the goal of reducing systemic risk created by the long-standing accumulation of local government debt.
Given the unique circumstances of China’s financial system at present, neither QE nor deficit monetisation are considered appropriate tools for these goals by central government policymakers.
“Reference to the need to expand the monetary policy tool kit and the central bank gradually increasing the purchase and sale of treasuries as part of open market operations is made against a broader background of deleveraging,” Wen said.
He highlighted several reasons as to why QE is not currently applicable for China’s monetary policy operation amidst efforts to step up deleveraging and reduce local government debt risk:
- China’s finance system is dominated by indirect financing via the banks, with rates set by PBOC via policy rates and the loan prime rate (LPR). If QE is used to change the yield curve for treasuries, this will not directly affect rates for loans, which are based more on the LPR.
- Trading on China’s market for treasuries remains active, and there are no pressing liquidity issues.
- In quantitative terms, the central bank still has ample room for cuts to interest rates or the required reserve rates, as stated on multiple occasions by PBOC governor Pan Gongsheng in March.
Can the Chinese central bank use MMT to justify debt monetisation?
In addition to speculation of QE achieved via treasury purchases, state-media reports that rumours have emerged that China could engage in direct debt monetisation by the central bank, as rationalised by the principles of Modern Monetary Theory (MMT)
“QE uses large-scale purchases of assets on secondary markets – including treasuries as well as MBS and REITs, while MMT is the use of direct purchase of treasuries on the primary market to expand the central bank balance sheet, a practice which is currently prohibited by law,” Wen Bin said.
Wen views MMT to be a key rationale for “deficit monetisation,” considering it to be a “theory that mainly advocates the use of fiscal expansion to create money, in order to help the economy to attain the goal of full employment.”
Wen points out, however, that China’s current monetary policy system makes it impossible for Beijing to directly implement debt monetisation in accordance with MMT.
Following the launch of efforts to reform the financial system in the 1990’s under Premier Zhu Rongji, China sought to emulate the best practices of advanced economies with regard to monetary policy and the banking sector.
As a consequence, PBOC is not in a position to engage in direct debt monetisation or money printing, which would involve the Chinese government borrowing directly from PBOC to finance public spending.
Article 29 of the “People’s Bank of China Law” (中国人民银行法) stipulates that “PBOC cannot provide financial overdrafts for the government, and cannot directly purchase or underwrite treasuries or other government bonds.”
As with most other monetary policy regimes, PBOC does not purchase government bonds directly on the primary market, but instead engages in trading of the instruments on the secondary market as part of its open market operations, including short-term repo operations that make use of treasuries as collateral.
The purpose of such operations are also the same as those of other monetary policy systems, being to institute changes to the money supply or short-term interest rates, as a means of adjusting levels of economic activity.
Deleveraging to take place amidst loose monetary and fiscal policy
Wen points that while debt risk is always a problem during economic downturns, it’s an especially acute challenge for local governments in China, given their reliance upon revenue derived from land rights sales which tend to slacken as the economy stalls.
For this reason, resolving the debt risk of local governments is currently one of the foremost concerns of China’s economic policymakers.
“As debt problems gradually become more apparent, at the central government level, at least four authorities will become involved in the current round of debt resolution – the fiscal authorities, the monetary authorities (central bank), the bond management authorities (bond trading associations and exchanges) and financial institutions (policy banks and big state-owned banks),” Wen said.
A key way in which China’s monetary policy system does differ from that of other economies – in particular representative democracies, is the close coordination of fiscal and monetary policy.
While democracies tend to place monetary policy under the remit of an independent authority to prevent undue monetary expansion in the lead up to elections, in the Chinese system both fiscal policy and monetary policy are under the authority of the State Council, via its control of the Ministry of Finance and PBOC.
Given prevailing economic challenges, however, Wen believes that policymakers will seek to gradually defuse these debt problems amidst a coordinated environment of loose monetary policy and active fiscal policy.
“A raft of debt resolution measures must be performed amidst a financial environment of loose monetary policy and loose fiscal policy.
“The central bank will firstly use monetary tools for loosening, then government departments will gradually unveil a batch of tools for swaps, term extensions and rate reductions.
“For this reason, 2024 will see the continuation of the coordinated exertion of loose monetary and loose fiscal policy.”