Despite rate cuts, aggressive Chinese monetary policy easing is not on the cards

With a property slump and pandemic-induced weak consumption dragging down the economy, the PBOC has limited room for manoeuvre
Policymakers will not want to undermine the policy goal of curbing property speculation, and their hands are tied in the face of the zero-Covid policy

Hao Zhou

Published: 6:45am, 5 Jan 2022

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In the last month of 2021, China’s central bank first unexpectedly cut the reserve requirement for deposits and then lowered the benchmark lending rate, which again fuelled speculation that massive easing was imminent.

While this may sound reasonable, given the economic headwinds facing the economy, investors should also be aware that there is limited room for easing in China, which means that aggressive easing is probably not on the cards in the coming year.

Despite continued data weakness, market expectations on policy easing had been largely dispelled before the reserve requirement ratio (RRR) cut in December, with PBOC officers repeatedly stressing that there was no need for such a move.

Nonetheless, the surprising decision on the reserve requirement in December, days after Premier Li Keqiang signalled a cut was in the works, quickly turned around market expectations. And the cut in the loan prime rate only raised hopes for further policy easing.

China’s top leaders attend the Central Economic Work Conference in Beijing on December 10. Photo: Xinhua via AP

To be sure, some easing is necessary. The Chinese economy has been softening rapidly since the second quarter of 2021. And, at the Central Economic Work Conference last month, the country’s top leaders acknowledged that downward pressure had intensified and market expectations were deteriorating.

The overall policy stance needed to be supportive. Hence, the December cuts were rolled out. On the fiscal front, the government also ramped up the issuance of special purpose bonds that are widely used for infrastructure investment before the end of 2021.

However, markets should keep in mind that Chinese policymakers have limited room for manoeuvre.

First, we need to understand that the most important factor behind the economic slowdown is weak domestic demand. This is largely due to softness in the property sector and sluggish consumption, owing to Beijing’s zero-Covid strategy.

In the property sector, there is little sign that the weak momentum will turn around in the next couple of quarters. In most big cities, property sales have fallen sharply, with housing prices highlighting this weakening momentum. If the housing market’s historical performance is any guide, the downward trend is likely to extend to the second half of this year.

In addition, the expansion of property tax trials could weigh on the housing market in the medium term. The Central Economic Work Conference also reiterated that “housing is for living in, not for speculation”, suggesting that property financing would still be under scrutiny from the regulators.

This also implies that monetary policy is unlikely to be eased massively as history suggests this would eventually boost the housing market.

On the consumption front, the zero-Covid strategy implemented by Beijing has significantly changed consumer behaviour. With the various travel restrictions in place, people now mostly travel only out of necessity. Many have also reduced their leisure activities.

If China sticks to its zero-Covid strategy, consumption will struggle to return to its pre-pandemic levels. In other words, monetary policy easing is not the right solution for boosting domestic demand.

The Chinese central bank also faces supply-side restraints. In its latest monetary policy implementation report, the PBOC reiterated that it would continue to manage the growth of aggregate financing in tandem with nominal GDP growth, aiming to maintain a stable macro leverage ratio.

China’s credit growth was estimated to be about 10 per cent in 2021, largely in line with nominal GDP growth. However, the consensus view is that nominal growth is likely to decelerate to about 8 per cent in 2022, which implies that credit growth would see downside pressure in the next few quarters.

This means that, while the policy rates could be cut to ease the debt burden for the economy, the overall credit conditions are unlikely to be relaxed significantly.

A Bank of China branch in Shanghai is seen on December 28. While policy rates could be cut to ease the debt burden for the economy, the overall credit conditions in China are unlikely to be relaxed significantly. Photo: Bloomberg

Meanwhile, the risk appetite among commercial banks has been badly dampened due to the economic slowdown and property market slump. This also means that banks will remain cautious in extending credit in the coming quarters. In other words, the effectiveness of monetary policy easing is questionable.

All told, while the market has again been cheered by hopes of policy easing, the actual policy rollout in the coming year will probably be slow and hesitant. The market is likely to be disappointed on the monetary policy front.

In the meantime, the pro-cyclical behaviour among commercial banks also suggests that any policy easing might be less effective than policymakers thought.

The real hope, in my view, is that fiscal spending could be accelerated in 2022, suggesting that the investment in infrastructure would provide some support to the economy, particularly in a property downturn. If the issuance of local government special bonds could pick up significantly in the first quarter, fiscal support would materialise in the following few quarters.

However, as underlying demand remains weak, China’s economic outlook still appears to be challenging, for now at least.

Hao Zhou is senior emerging markets economist at Commerzbank