China's central bank spurring economy with new liquidity injection

Current debt woes may be immediately soothed by a new liquidity injection but the deeper problem still exists and it may snowball into even bigger crisis down the road. A fiscal policy of tax cuts shall be more preferable as it also stabilizes the economy growth without creating long-term pitfalls.

A staff member walks in front of the headquarters of the People's Bank of China, the central bank, in Beijing. Photo: Reuters

Since the start of this year, the impact of multi-year de-leveraging campaign by the central government has taken its toll as demonstrated by record number of bond defaults, stock market crash and meltdown of P2P lending platforms. In addition to financial market turmoil, companies that used to borrow to make a living, including HNA and Wanda, have also hit a credit crunch. For real estate companies, the leverage ratio is so high that most of the property developers found themselves grappling with a deep debt crisis. As debt is not paid back, the banking sector is in jeopardy. According to a McKinsey report, the non-performing asset ratio of the Chinese banks is likely to rise to 15% in 2019, exceeding the warning line by a whopping 10%, which is mind-boggling to other countries.

When it comes to the three traditional carriages that drive GDP growth, consumption, investment and exports are all walking against headwinds. In terms of consumption, the low growth rate of total retail sales of consumer goods in May has seen no significant improvement in last month. Under the weight of skyrocketing housing price, the middle class began to self-downgrade their consumption to pay back mortgages. For investment, the growth rate of social financing fell to 9.8% in the first half of this year, and the investment growth rate hit a record low of 6%. Only the growth rate of real estate investment was relatively high, while the growth rate of manufacturing and infrastructure investments continued to underperform. For exports, in the first half of this year, China’s exports to the United States increased by only 5.4%, a considerable reduction of 13.9% compared with the same period last year.

Faced with the risk of Sino-US trade war, looming debt crisis and weak economic growth, the central bank launched a one-time medium-term loan facility (MLF) of RMB 502 billion with an interest rate of 3.30%, on a par with last time, in the latest move to inject massive liquidity into the system. In the words of the State Council meeting, "Fiscal policy should be more active" and " monetary policy should be appropriate."

In simple words, monetary easing seems inevitable. Beijing wants to save the day and doesn't want the funding chain of the real economy to be tightened too much to the extent that it finally breaks and threatens social stability.

Will real economy benefit from a liquidity injection?

In 2017, the real economy leverage ratio of residents, non-financial companies and government departments rose from 239.7% in 2016 to 242.1%, an increase of 2.4 percentage points, significantly higher than the average of 193.6% in emerging economies, and even higher than many developed economies.

Regarding government debt, as of the end of 2017, China's local government debt was 16.47 trillion yuan, and the debt ratio (debt balance/comprehensive financial strength) was 76.5%. Combined with the central government debt of 13.48 trillion yuan, the Chinese government debt totals 29.95 trillion yuan. Worse still, this data only covers explicit debt. If the implicit debt of local financing platforms is added, the debt level will be even more scary. The former deputy director of the NPC Financial and Economic Committee said that China’s local debt is about 40 trillion yuan, but no local government wants to pay off debts, many of them cannot even afford the interest.

As for the leverage ratio of non-financial enterprises, corporate debt (mainly state-owned enterprises) is also high, accounting for 167% of the total GDP, far exceeding the red warning line. Although the leverage ratio of private enterprises is relatively low, but when the central bank release liquidity, it usually flows into state-owned enterprises. Banks are very reluctant to finance private and small enterprises.

In terms of the debt ratio of the residential sector, as of the end of 2017, the leverage ratio of Chinese residents is as high as 110.9%, which has exceeded 108.1% of the US.

As can be seen from the above, whether it is the local government, corporate, or residents, the leverage rates are all at an unprecedented high. Their debt woes may be immediately soothed by a liquidity injection but the deeper problem still exists and it may snowball into an even bigger crisis down the road.

Will the property market rebound from the current malaise?

This round of monetary easing is primarily aimed at boosting the real economy especially the private sectors. The strict supervision of the housing market won’t be loosened in the foreseeable future, hence it is difficult and unrealistic to bypass the supervision and invest money into the property market. The property market’s current downward trend is not solely determined by demand, but essentially driven by the government policy.

In first-tier cities, heavy handed measures for cooling down the market are still in place to prevent any speculation. Second-tier cities have seen a rise in demand, but they have also taken measures to suppress speculation by housing price limit, purchase limit, restricted loans, and sales limit. In other lower tier cities, the recent bull run of housing prices may come to an end as the government is tightening approvals for shantytown renovation projects.

Will it stoke inflation?

China has already been in inflation if we ruled out the pork factor from the CPI basket. The reason the CPI looks relatively moderate is due to the falling price of pork which accounts for a big proportion in the CPI basket. From the beginning of this year, the rising cost of consumer food products and dining out cant' be missed out by those who are price sensitive.

In the past 10 years, the currency released into circulation has been astronomical. In 2007, the total amount of China's broad money M2 was 40 trillion yuan, by 2017 it reached 167 trillion yuan, increasing by more than four times. In 2007, bank financing was only 530 billion yuan, and by 2017 it had reached 30 trillion yuan, a 60-fold increase. Therefore, after adding the shadow banking factor, the real money in China in 2017 reached 200 trillion yuan, five times more than in 2007.

Then why is there no visible inflation caused by such huge amount of money? The reason is that de-leveraging has led to a large part of such liquidity entering the property market, which is also the root cause of the soaring housing prices in the past 10 years. According to historical experience, when the real estate is in inflation, the real economy is deflated. However, since this round of monetary easing is aimed at boosting the real economy, much of the liquidity will inevitably flow into the real economy to cause inflation.

Tax cuts may be more favorable

What should be done in fiscal policy is a big, sincere tax cut. If more money is given to the residents and enterprises, the economy will be better and more efficient by directly reducing the burden on residents and enterprises. Money can be better used in the hands of the residents and entrepreneurs rather than the government. What’s more, tax cuts can stabilize economic growth without creating long-term crisis as monetary policies do.

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