The latest installment of easing arrived in China last night, from the WSJ:
China is launching a broad stimulus to help local governments restructure trillions of dollars in debts while prodding banks to lend more, as fresh data added to signs of a worsening slowdown in the world’s second-largest economy.
In a joint directive marked “extra urgent,” China’s Finance Ministry, central bank and top banking regulator laid out a package of measures to jump-start one of the government’s most important economic-rescue initiatives: a debt-for-bond swap program aimed at giving provinces and cities some breathing room in repaying debts.
Central to the directive is a bigger-than-expected plan by the People’s Bank of China that will let commercial banks use local-government bailout bonds they purchase as collateral for all kinds of low-cost loans from the central bank. The goal is to provide Chinese banks with more funds to make new loans. The directive was issued earlier this week to governments across the country and reviewed by The Wall Street Journal.
…“The central bank is using this opportunity to provide cheap funding to commercial banks and guide down interest rates,” said China economist Zhu Chaoping at UOB Kay Hian Holdings Ltd., a Singapore-based investment bank. “This will have similar effects as quantitative easing,” Mr. Zhu said, referring to the bond-buying programs used by the U.S. and European central banks to spur economic growth.
BNP Paribas’ Richard Iley via FTAlphaville explains the implications:
The release of preliminary data on China’s Q1 balance of
payments, while incomplete, nonetheless furnishes us with the hardest evidence yet of the alarming scale of hot money outflows from the mainland. By construction, the change in foreign assets (FX reserves) is the sum of the basic balance (current account + net foreign direct investment) + net hot money flows (basically bond and equity investments + bank lending) + ‘errors and omissions’. The latter works as a balancing item and so reflects hot money flows not captured in recorded flows.
Full detail of the Q1 data is not yet available but China enjoyed a bumper basic balance surplus of $129.2bn (current account surplus $78.9bn; net FDI inflows of $50.2bn) even as official reserve assets fell by $80.2bn. With total capital account in deficit to the tune of $78.9bn i.e. net outflows, recorded hot money outflows were also -$129.2, leaving a huge ‘errors and omissions’ balancing item of -$80.2bn in the first quarter. This is easily a record deficit for the balancing item and necessarily implies accelerating unrecorded hot money outflows. On an annualised basis, ‘errors and omissions’ were worth just over $320bn which equates to a record 3.5% of GDP. Over the past year, ‘errors and omissions’ have totalled $244bn.
Adding the ‘errors and omissions’ deficit to recorded net hot money outflows gives an aggregate estimate of overall hot outflows or capital flight from the mainland. By construction, this slumped to a record $209.5bn ($838bn annualised) or an eye-watering 9¼% of GDP (Chart 2). Overall, in the year to Q1, China has seen capital flight of $584bn or 5.6% of GDP.
In an Austro-Chinese, excess capacity model of the business cycle, there is a gain and a loss from cutting interest rates when an economy is well into the over-expansion phase. The gain is that you may mitigate the costs of the “secondary deflation,” as the Austrians call it. The cost is that you may overextend the excess capacity even further. That is a call the central bank must make, noting that the excess capacity model applies only with some probability.
Validation of depreciation expectations would risk further accelerating bets on yet more weakness and leave the central bank chasing its tail. Any modest tinkering such as further widening of the CNY’s daily trading band from its current +/-2% will be delayed until the PBoC has more decisively stared down depreciation speculation. In the short-term that leaves China unable to fight back in the currency wars and having to ‘wear’ the biggest competitiveness shock to the economy since the Asia crisis, which, as we predicted, is pushing export growth close to zero so far this year.
Without an unlikely rapid tailing off of capital outflows, the authorities therefore look to have little choice but to press on with more RRR cuts to reverse the de facto sterilisation of prior FX reserve accumulation and also to accelerate the backdoor QE* that the PBoC quietly started last year. Via increased claims to depository institutions under its Pledged Supplementary Scheme (PSL), PBoC’s domestic assets have already increased by around 2½% of GDP over the last year. Although the biggest increase in a decade, this only offsets about 2/3rds of the drain on the monetary base from falling foreign assets… More is clearly required with outright purchases of, or the acceptance as collateral, of local government debt an obvious candidate to further boost the balance sheet.
In short, China is fighting a giant monetary suck hole that is neutralising all stimulus efforts. This is basically the tide going out on post-GFC hot money flows when endless US loosening and a falling dollar super-charged Chinese credit via the currency peg and fixed capital account.
So long as the combined forces of Chinese slowing and capital account opening combine with US repair and approaching tightening, the outflow will continue and China will struggle to find stimulus traction.
