China pressgangs monetary policy in service of property market, regional deleveraging

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As a macroeconomic tool, conventional monetary policy focuses on adjustments to interest rates and the money supply to either curb inflation, or boost economic growth and rates of employment. 

China, however, currently implements a more interventionist brand of monetary policy with a broader remit of discretion. 

In addition to the standard tool of interest rate adjustments, it also encompasses the guidance of credit towards specific areas of the economy, and enlisting the active support of the state-owned banks in fulfilling the strategic policy goals of the central government. 

The country’s top policymakers have indicated that they plan to make full recourse to these monetary policy tools to deal with prevailing sources of risk in the Chinese economy – chief amongst them an enervated property market and exorbitant levels of local government debt. 

Communist Party signals concern over systemic risk

Systemic risk in China’s financial system was at the top of the agenda for the latest meeting of the Communist Party’s Politburo. 

The meeting of the Politburo convened on 30 April called for “continuing to prevent and dissolve risk and key areas,” with an especial focus on the real estate sector and local government debt. 

The Politburo called for “deeply implementing plans for the resolution of local government debt risk” and “expediting the high-quality development of real estate.”

Domestic analysts say dealing with both these sources of financial risk will involve the use of a variety of monetary policy tools, including credit and interest rate guidance, alongside growth in the money supply via direct injections or reserve ratio cuts. 

Monetary policy report flags credit support for property

The People’s Bank of China (PBOC) – the Chinese central bank, said it would seek to deal with the challenges of the faltering property market by means of tailored lending policies.

In its Q1 monetary policy execution report (2024年第一季度中国货币政策执行报告) released on 10 May, PBOC said it would “expedite the stable and healthy development of the real estate market ” via recourse to a slew of measures. 

Chief amongst these measures would be the drafting and targeted implementation of tailored home loan policies for individual cities. 

PBOC also said that it would give greater support to inelastic housing demand and home upgrade demand, as well as research other policy measures to consume real estate inventory and optimize housing growth. 

Central bank channels credit towards property 

Feng Lin (冯琳), head of Golden Credit Rating’s Research Development Market, said to Securities Daily that monetary policy measures to alleviate property market risk will focus on expanding financial support for real estate enterprises, and “effectively containing the credit risk of leading, high-quality companies.”

Explicit credit guidance will play a key role in this process. Yan Yuejin (严跃进), head of the Yiju Research Institute, highlighted the need to “actively direct funds towards [real estate] projects.”

As of the end of March, Chinese commercial banks had already completed their review of the first batch of “white list” projects that was submitted by the Municipal Real Estate Finance Coordination Mechanism (城市房地产融资协调机制) for credit approval. 

The list contains more than 2100 real estate projects, for a total sum of more than 520 billion yuan in funds. 

Structured money policy tools

One of PBOC’s key means of exercising credit guidance lies in the use of structured monetary policy tools such as pledged supplementary lending (PSL), which can channel financing towards specific economic sectors. 

PSL were first launched by PBOC in April 2014, to serve as a new channel for the injection of base money into the banking system and the fine-tuning of interest rates. The instruments enable commercial banks to obtain loans from the Chinese central bank using collateral in the form of high-quality financial assets, conditioning on the provision of credit to designated areas.

At a press conference held on 18 March, Zhu Hexin (朱鹤新), PBOC deputy governor and head of the State Administration of Foreign Exchange (SAFE), said the central bank had issued 500 billion yuan in PSL to support projects including the construction of social housing, infrastructure development and urban upgrades.  

Zhu’s remarks arrive following the release of plans in February 2023 for the provision of loans to support the development of rental housing around China. 

“The structured monetary policy employed by the central bank over the past two years fully embodies its guidance priorities and focal points,” Yan Yuejin said. 

Interest rates set to further decline 

In addition to credit guidance and liquidity expansion, domestic analysts also expect further rate cuts from PBOC to alleviate financing costs. 

This will include cuts to benchmark rates, alongside credit guidance that prompts commercial banks to reduce mortgage rates. 

In February, China’s benchmark loan prime rate (LPR) posted its largest decline on record, with the five-year rate falling 25 basis points from 4.2% to 3.95%. 

Feng Lin said the fall in the 5-year LPR was for the purpose of “effectively reducing the cost for households to buy homes,” and that it “played a key role in stabilising property market expectations.”

PBOC could also push for more targeted cuts to interest rates, and put pressure on commercial banks to reduce the floor for rates on first and second home loans. 

“In March the lending rate for personal home loans was 3.71%, which clearly indicates that there is still ample room for policy action,” Feng said. 

Liquidity expansion to support regional deleveraging 

Feng Lin said efforts to deal with local government debt risk would involve the active participation of both commercial banks and the Chinese central bank. 

Chinese commercial banks will engage more closely with the local financing platforms (LFP) that have long served as a key source of hidden leverage and debt risk for governments at the provincial and municipal levels. 

Key measures for alleviating the debt burdens of these financing vehicles will include debt-equity swaps, as well as term extensions and interest rate reductions for outstanding loans. 

Analysts say that given the scale of local government leverage, the process will require ample support from the Chinese central bank on the monetary policy front. 

This will primarily assume the form of growth in medium and long-term liquidity, to back banks participating in debt-equity swaps for local government financing platforms. 

In order to provide this liquidity support, PBOC could implement further cuts to the required reserve ratio or expand the volume of its medium-term lending facilities (MLF) – one of the main instruments employed in its open market operations. 

In February PBOC made its first cut to the reserve ratio for 2024, paving the way for banks to provide more long-term funding. 

The 0.5 percentage point cut exceeded the cumulative scale of reduction over the past two years, during a period when Chinese regulators were preoccupied with keeping the economy afloat in the immediate wake of the Covid pandemic.