Over the past month we have observed China announcing a slew of easing measures, both monetary and fiscal, in quick succession: there has been a cut in the reserve ratio requirement (RRR) for commercial banks, easing of regulatory norms to support broader credit growth, a call for more “proactive” fiscal policy, and accelerated issuance of local government bonds to support infrastructure investment. As these steps contradict the tightening path that Beijing has pursued since April 2016, it has provoked confusion from investors.
So, in an attempt to answer some of these lingering question, Morgan Stanley’s chief Asian economist Chetan Ahya writes that he thinks China’s easing is defensive in nature, aimed at sustaining a moderate pace of growth, and not a shift to an offensive stance (i.e., to accelerate GDP growth). Nonetheless, he also note that “it signals a readiness to act” and adds that “if trade tensions create a meaningful risk to growth, we should expect a much more vigorous – though still defensive – policy response.”
Here are the key questions asked by investors, and Morgan Stanley’s responses:
(1) Do these measures indicate a change in China’s policy stance?
We think China’s recent easing measures aim at maintaining a neutral policy stance. Our framework for assessing policy is to look at the pace of broad credit growth, which policy-makers call ‘total social financing’. Our chief China economist, Robin Xing, believes that broad credit growth will stabilise at around 11%Y in 2H18. Before these measures were announced, investors probably believed that policy-makers would stay on a tightening path, with the expectation that broad credit growth would continue to decelerate (as it had since April 2016 when it was growing at 16%Y). The recent measures have changed these expectations, while increasing confidence that policy-makers will be able to stabilise credit growth.
(2) Why have policy-makers taken these measures?
This easing is defensive and pre-emptive in nature. We think policy-makers have adopted these measures to guard against potential negative repercussions of trade tensions and their knock-on impact on external demand, not in reaction to slowing domestic demand. Indeed, our recent work suggests a 16bp effect on China’s growth from the trade measures implemented recently, considering both direct and supply chain effects, though this could rise to 70bp if a 10% tariff were imposed on all US imports from China (a total of US$500 billion).
(3) Are they sacrificing their policy reform agenda to protect growth?
We think the reform agenda remains in place. Since 2016, policy-makers have been at work on supply-side reforms (cutting excess capacity) and cleaning up the financial system. They have made good progress, according to our materials analyst Rachel Zhang and financials analyst Richard Xu, with the rate of improvement currently pegged at 60-70%. We believe financial clean-up remains in focus, as the RRR cuts are designed to avoid over-tightening. And policy-makers are continuing to implement supply-side reforms via increased focus on environmental protection.
(4) Will RMB face significant depreciation pressure again?
The recent depreciation has been triggered by concerns about trade tensions and the potential divergence between the US and China on monetary policy. Despite comments from policy-makers aimed at stabilising the exchange rate, market pressures have led to continued depreciation. However, to put the recent currency moves in a broader context, much of the seemingly sharper depreciation in fact has reversed the appreciation that occurred from February to mid-June (with RMB strengthening by 3% against its currency basket even though the trade-weighted USD appreciated by 7%). We think RMB will likely return to a regime of relative stability in the trade-weighted exchange rate. In other words, if the broad trade-weighted USD depreciates, RMB should appreciate.
Morgan Stanley concludes that “all things considered, given that the policy stance in China should not be a game-changer, our strategy teams remain cautious on both DM and EM risk assets.” But perhaps an even greater threat to China’s stability than trade wars or slowing credit growth, are “the lingering concerns about the ongoing Fed tightening cycle, elevated trade tensions and their attendant impact on global growth.“
In other words, if the US wants to truly hurt China, it can simply by ratcheting up rates, which eventually could cause a series of financial crises in Beijing, a topic which will be further discusses in a subsequent post by One River Asset Management CIO Eric Peters.
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