In our view, there are good grounds for believing that China’s monetary transmission mechanism has lost effectiveness since the pandemic. A more aggressive approach to monetary easing may be needed from the People’s Bank of China.
This article is an extract from a paper entitled ‘Implications of China’s impaired monetary transmission mechanism’ – you can read the full paper here.
The severity of the problem is underscored by the absence of a sustained recovery in the credit impulse – new credit flows to the economy as a share of GDP – despite several rounds of monetary easing (see Exhibit 1).
Three years of Zero Covid policies, the tightening of regulations (notably on the tech sector) between 2020 and 2022, and chronic weakness in the property sector since the pandemic have destroyed public confidence and blunted the effect of policy easing on China’s growth momentum and ‘animal spirits’. As a result, private consumption and investment have failed to respond to the authorities’ easing measures.
Beijing’s ‘incremental easing’ approach over the last two years has not helped turn the situation around. The measures have been insufficient, especially when monetary transmission is impaired.
Throughout the pandemic, the People’s Bank of China (PBoC) chose not to expand its balance sheet aggressively to pump-prime the economy. Its developed market central bank counterparts, by contrast, engaged in quantitative easing through massive balance sheet expansion.
Unlike governments in many developed markets, China refrained from additional fiscal support for consumers during the pandemic. The difference in fiscal policy explains the lack of a recovery in consumption in China post-Covid compared to the robust growth seen in the West.
Granted, Beijing wants to quit the old debt-fuelled, supply-expansion growth model. It is therefore willing to tolerate the slower growth which results from a focus on structural reforms and debt reduction. However, we think this deflationary policy approach runs the risk of overestimating the economy’s resilience to negative shocks and could deprive it of recovery momentum.
In our view, the loss of monetary transmission efficacy suggests that the PBoC would have to ease policy more aggressively and do this for longer than in previous cycles for it to have the same impact on growth.
Realising that China’s property market woes are spreading the risk of deflation (see Exhibit 2), Beijing has ramped up its measures to stabilise the sector, notably by accelerating urban village renovation and social housing construction, as well as by increasing financing for viable non state-owned developers.
The PBoC has announced a plan to inject more than RMB 1 trillion to fund property and infrastructure investment in major cities and has drawn up a ‘whitelist’ of 50 developers deemed to merit credit support.
The risk, however, is the timing of the implementation.
At the time of writing, many of these measures have yet to be carried out.
In our view, the cyclical outlook for Chinese assets in 2024 hinges upon Beijing’s reaction to feeble economic growth momentum. As we have previously argued, a ‘pain point’ might have been reached, prompting Beijing to pursue more assertive easing than it has over the past two years (see “Chi Flash: Beijing mulls aggressive easing as ‘pain point’ hit”, 15 November 2023”). The loss of monetary transmission effectiveness appears to reinforce such an argument.
If Beijing can keep up more robust easing in the coming months, rebuilding confidence and convincing markets that the country’s outlook is improving, we believe there is a fair chance of a sustained rebound in economic growth and stock market performance in 2024.
If not, we could see growth stuck in a low gear, which may weaken Chinese asset prices.