The writer is professor of finance at the Shanghai Advanced Institute of Finance
Recent swings in global financial markets have occurred partly because the market is unsure of the direction of post-Covid economic policy in the US and China. While inflation is probably the most daunting challenge facing the US Federal Reserve, growth has become the focal point of the People’s Bank of China’s deliberations.
Given that “stability” is the keyword for China’s economic policy in 2022, some investors have been surprised that the PBoC’s monetary policy has not been as active as they might have hoped. And such sentiment has grown stronger after a number of Chinese cities went into lockdowns of varying degrees of severity in response to the spread of the Omicron variant of Covid-19.
Earlier this week, China’s premier, Li Keqiang, warned that the world’s second-largest economy could struggle to record positive growth in the current quarter. “We will try to make sure the economy grows in the second quarter,” he said. “This is not a high target and a far cry from our 5.5 per cent goal.”
Some argue that the slowdown of the Chinese economy is so alarming that aggressive monetary easing aimed at stabilising growth at all costs is urgently needed.
In fairness to the central bank, the art of balancing multiple policy objectives has never been easy, even in a “normal” economic environment and calmer market conditions. The PBoC faces a range of challenges, from stabilising the renminbi exchange rate overseas to pushing forward with financial reform domestically. Such objectives do not always align well with each other and may even come into conflict from time to time.
If anything, Covid has made the central bank’s balancing act even more delicate. On the one hand, the pandemic-induced economic slowdown, coupled with China’s continuing transition to a more sustainable growth model, poses a challenge to the PBoC as it seeks to maintain growth and ensure employment.
On the other hand, surging inflation is forcing central banks around the world to taper stimulus programmes and raise interest rates much faster than previously expected. Such moves by its international counterparts limit the PBoC’s room for manoeuvre.
Further easing may lead to a weakening of the renminbi. While a weaker yuan would probably help China’s export and trade balance, it would also make it less attractive for foreign investors to hold yuan-denominated assets.
Domestically, a strong dose of monetary easing may achieve the desirable goal of boosting short-term growth. But it would risk inflating stock and housing bubbles. To make things more challenging still, it is not certain that further monetary easing would even achieve its intended goal. The effects of previous rounds of stimulus dissipated quickly and failed to turn around the tepid demand in borrowing in the real economy, especially by small and medium-sized enterprises.
Covid did not cause many of the problems in the Chinese economy — but it did make them more acute. Many of the difficulties the PBoC faces can be traced back to the Rmb4tn fiscal stimulus programme of 2009. House prices and debt levels have since climbed sharply, with echoes of the credit-fuelled economic boom and bust in Japan in the late 1980s and in the United States before the global financial crisis.
What would have helped in the US and Japan back then, and what the PBoC needs to focus on today, is better expectation management. The deeply rooted and widespread belief that the Chinese government will always do whatever it can to guarantee breakneck growth and rapidly growing asset prices has itself become a serious risk. The irresponsible borrowing, aggressive investment, surging housing prices and leverage that followed the 2009 stimulus subsequently constrained the PBoC’s ability to act during the Covid pandemic.
Chinese leaders have expressed concern that an overly optimistic mentality could eventually lead to financial crisis and systemic risks. And such worries may also be tying the PBoC’s hands when it comes to rolling out more aggressive monetary stimulus in response to recent lockdowns.
In the PBoC’s defence, China’s broader economic policy arguably already took an important, if subtle, turn well before the pandemic struck. With policy priorities transitioning from the old high-speed growth model to a more sustainable, inclusive and ecologically friendly high-quality model in the future, it should probably come as no surprise that Beijing’s monetary policy would adjust accordingly.