Alicia García Herrero (Natixis) | The PBoC cut the Required Reserve Ratio (RRR) by 0.5 percentage points yesterday, amid the economic slowdown. This should not surprise us, as China is in the midst of a cyclical slowdown. However, the move has happened when China’s PPI and CPI have just edged up to 13.5% and 1.5% from 10.7% and 0.7% respectively in November. The message to the market is clear: avoiding a too rapid economic deceleration is the policy priority, leading to the start of a monetary easing cycle.
The downward economic pressure has already been mounting for a while after the strong post-Covid rebound in the first quarter of this year. Even though households recouped their interest to consume, retail sales were still only moderately supportive because of the more sluggish growth in household’s income. Investment was even weaker after the government’s regulation tightening on the real estate, technology and education sectors, let alone the limited support from infrastructure investment. During Q3 2021, the contribution from investment to China’s GDP growth plummeted to nearly zero. Exports remained strong thanks to the global economic recovery, but the momentum of external demand is bound to ease with slower growth globally, especially in the US.
Against the backdrop, the Chinese government is really in need of supportive policies to achieve a decent growth number, namely above 5% in 2022. This is especially true given the time lag for the policies to showcase their effects.
We believe that this RRR cut is the first step in the PBoC’s easing cycle. Past experience supports this idea with five RRR cuts during the easing cycle from 2015 to 2016, and six times during the one from 2017 to 2019. The situation will be particularly pivoted towards further easing if the economy continues to slow down in the first half of 2022. That said, there may be some fine-tuning during the implementation of the monetary easing, i.e., replacing some of the MLF due at the end of the year with the liquidity unleashed through the RRR cut, but the overall tone will only become sharper early next year.
Beyond easing through the RRR adjustment, the government will also need to reconsider the macroprudential measures, which were used for containing financial risks, especially in the real estate market. While it seems very determined, and also structurally reasonable, for the Chinese government to steer the economy away from the property-led model for sustainable growth, the rapid deterioration of the real estate sectors is bound to have serious implications for the Chinese economy as well as financial markets. During the past few quarters, both the development financing loans to the developers and the mortgage loans for purchasing house have decelerated significantly. Some easing of liquidity is, thus, key at the moment for the survival of Chinese developers, and, broadly speaking, for the stabilization of the Chinese economy. The latest Politburo meeting seems to have justified the direction as it shifted the policy tone from restrictive to supportive by stating that it will allow property market to better meet reasonable home demand. In other words, at least to some extents, the government wants to soften the regulation measures for the development of the property market.
In addition to monetary expansion, the government will also need to go for a laxer fiscal stance. The issuance of the local government special bond was rather slow during most of the time in 2021, and the infrastructure investment has even been growing negatively year-on-year since May. Because the government-led infrastructure growth was another key for China’s economic growth in the past, it will also be a natural tool in the next year to fight with the slowdown, especially if the inflation pressure starts to ease. The laxer fiscal policies will also need to be accommodated with larger liquidity injections to ensure a stable funding cost environment for Chinese corporates.
All in all, we expect yesterday’s RRR cut to kick off a new cycle of monetary easing. We expect more measures to come in the first half of next year. It is important also to note that China’s policy turn at a time when most major central banks, and especially the FED, will start tapering and, possibly, hike rates at a later stage. The divergence in monetary policies may entice portfolio outflows from China and thus revert the so-far strong performance of the RMB. While the future movement of the currency also depends on the trajectory of the USD, the change in policy tone from China now needs to be priced in as a very important factor.
