China’s central bank has put a brake on liquidity injections over the last month as it struggles to optimise funding support for the economy by fine-tuning the system through which additional funds result in more lending to businesses.

The People’s Bank of China (PBOC) has implemented a series of targeted liquidity injections so far this year to stabilise the economy by helping the agricultural sector and small businesses. However, these efforts have, so far, not resulted in a significant increase in new lending, leaving market liquidity levels higher than the central bank is comfortable.

To prevent liquidity from becoming excessive, the PBOC has maintained a neutral policy stance in its regular open market operations in the past month.

The PBOC did not add or drain liquidity from the interbank market again on Tuesday, repeating that “overall liquidity remains at a relatively high level”. It has not conducted an open market operation since October 26, the longest such stretch in three and a half years.

The central bank did not conduct a withdrawal or injection of funds in November after adding a net 460 billion yuan (US$67.21 billion) in October and mopping up 230 billion yuan in September, according to Bloomberg data.

The central bank hopes that the capital it injected into the market goes into the real economy rather than circulating the interbank market, said Qu Qiang, a researcher of the international monetary institute of the Renmin University of China.

While avoiding excessive liquidity in the financial system, the PBOC also aims to ensure lenders have sufficient liquidity to support private companies through other monetary policy tools.

Watch for another PBOC credit jolt to prop up economy soon

Analysts expect the PBOC is likely to roll over two medium-term loan facility loans to banks (MLFs) due this month, including a 288 billion yuan loan on December 6 and a 188 billion yuan loan on December 14.

To add liquidity, the central bank had also cut banks’ required reserve ratio – the amount of money they are required to hold at the central bank – four times this year, most recently in October, providing an additional US$110 billion in lending.

Reflecting overall easing of banking liquidity conditions, short-term money market rates have been edging lower this year.

However, banks have remained reluctant to lend to firms with weak credit histories. Instead they have been investing the extra cash in the market to earn interest income amid rising corporate defaults.

New bank loans in October fell by about half to 697 billion yuan from 1.38 trillion yuan in September, according to data from the central bank. Aggregate financing, which includes bank loans, equity financing, bond sales, trust funds and banker acceptance bills, shrank by about two-thirds to 728.8 billion yuan.

The Chinese government’s economic stimulus imperative to offset the impact of the trade war has collided with its continued effort to contain risks, leaving the PBOC with a dilemma it has not yet been able to solve.

In particular, small and medium-sized firms complain that lack of access to credit, or its high cost when it’s available, is preventing them from investing.

“The macroeconomic fundamentals have actually bounced back a little bit from the worst-case scenario. The de-escalation of trade tensions will also give the central bank more leeway [to refine its monetary policy],” Qu added.

Iris Pang, chief Greater China economist of ING Bank, said the central bank is also conveying the message that it has done its part in the economic stabilisation and no major monetary loosening should be expected in the period ahead.

“Now it’s the turn of fiscal policy to carry the responsibility [for advancing economic stimulus],” she said. “Compared to monetary easing, the impact of fiscal stimulus would last longer.”

China renews currency swap deals with UK, Japan to defend yuan

Still, analysts expect the PBOC to maintain its bias toward an easier monetary policy in the short term, with a further cut in the reserve requirement ratio possible in coming weeks.

“Its tone of structural deleveraging won’t change either,” said ANZ China economist Raymond Yeung. “But such issues like [improving the] monetary transmission mechanism can’t be solved in two or three years.”

The division among policymakers over the appropriate roles of monetary and fiscal policies became public in June, when Xu Zhong, head of the PBOC’s research bureau, accused the Finance Ministry of not being aggressive enough in tackling deep-rooted financial risks among local governments that kept government spending below the level needed to lift the national economy.

Their row came to an end after the Politburo, China’s top decision-making body, changed policy at the end of July to focus on stabilising the economy. From that point, the government loosened its purse strings to fund infrastructure spending and cut personal income taxes from October.

The federal government has been advancing money from next year’s budget to local governments after they breached the limit in October on the amount of bonds they can issue to fund additional spending.

To accommodate the additional spending, analysts now expect the government to raise its budget deficit target next year above this year’s target of 2.6 per cent.

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