Will China’s Magic Work?

The Chinese authorities have responded to the crisis by easing monetary policy with 5 times cut in the benchmark interest rate and 4 times reduction in the reserve requirement. I do entertain the possibility of further drop in policy rate and easing of the required reserve.

So far, the money supply and credit growth appear to suggest that it works well with M2 growing at 19.7% in the first two months this year compared to 15.9% in Q4 and total loans by financial institutions were up 24.2% in February. Companies are reportedly borrowing from banks in order to earn the spread between rates on term deposits, which are set by the PBOC and those on bankers’ acceptances, while banks like to see their commission revenues rise and to report strong loan growth.

While China’s expansion will have only moderate positive effects on world exports, I am already seeing some boost to Japanese, Taiwanese and Korean exports. Commodity producing countries stand to benefit more meaningfully from China’s stimulus policy with a pick up in imports of iron, coal and oil demand.

Having said that, after the Chinese New Year holiday in February, no less than 20 million migrant workers had lost their jobs. Wage growth in the export sector is likely to contract sharply.

With greater fiscal spending, it leads me to have optimistic outlook on China’s bond market. Out of the 4 trillion stimulus package, the central government will pay 1.18 trillion and just closed NPC projected a budget deficit of 950 billion, almost all of which will be financed by new government bond issuance. Local government debt issuance was introduced recently. The total amount will be limited to 200 billion with maturity of three years. Thus far, the risk of default is low because of the role of Ministry of Finance plays and the way local tax revenue is handled between the central and the local government.

Recent comments by top Chinese officials also suggest that they are becoming increasingly uncomfortable with the accumulation of foreign assets, notably US Treasuries and agencies that results from balance of payments surplus and the targeting of the reminbi exchange rate.

All this suggests that China wants to assert its growing economic weight in global affairs, albeit with characteristic prudence and gradualism.