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DOHA: As the US Federal Reserve continues to fuel rising interest rates, most emerging markets (EM) tighten monetary policy
. . The central bank of China, the People's Bank of China (PBoC), which still tightly manages its currency, the CNY, against the USD, had increased its short-term interest rates in response to the movements of the US Federal Reserve.
But after the Fed's 25-basis-point increase in mid-June, the PBoC has clearly failed, noted QNB's latest economic commentary on the world's second-largest economy
. a record 3.4% monthly decline in the CNY was reinforced by the announcement that the PBoC will reduce the reserve requirements of most banks by 50bp. The cut releases 700 billion yuan (1 percent of GDP) of additional liquidity into the banking system.
This decision follows a 1% reduction in reserve requirements in April. While the April move could be explained at least in part by a technical adjustment (offsetting the reduction in liquidity provided by other sources), the latest decline further reflects a deliberate easing of the policy.
Chinese decision-makers have tried to cope with it for much of the past two years.
After years of debt-driven economic growth that risks compromising longer-term financial stability, the authorities are trying to curb the excessive growth of credit and the reduction of debt levels.
At the same time, the authorities know that they can not over-tighten the policy with a view to deleveraging in case economic growth slows too much. 6% + GDP growth remains a political necessity. Given these conflicting, even contradictory, objectives, the authorities mainly used regulatory controls to try to control the riskiest off-balance sheet loan activity.
By limiting the liquidity of banks, market interest … rates have also been slightly raised for most of the last two years to slow, but not stall, overall credit growth.
Finding this balance is inevitably difficult, if not impossible.
Countries have managed to reduce the leverage of successive credit crashes over several years and avoid a painful hard economic landing. The latest data from China show the difficulty of the task and explain why the authorities now seem to be reversing the trend and starting to soften the policies. On the one hand, there is no doubt that the battle against excessive credit growth is finally won.
Total social financing, the largest measure of economic growth, collapsed in May.
On the other hand, the latest activity data shows a disconcerting weakness, signaling that the economic cost of the deleveraging campaign is becoming too high to be maintained just as it shows signs of work! Growth in retail sales and investment in fixed capital recorded its weakest growth last May.
Signs of weaker domestic demand materialized before the trade war between the United States and China was opened. Although the Chinese economy is rebalancing towards consumption-led growth, the export sector remains critical
In particular, external demand has been a key factor for the Chinese economy in 2017 with a trade net up 6.9%; His greatest contribution since the global financial crisis
. The growing threat to the export sector of a trade war with the United States further complicates the central bank's difficult balance, further tilting the balance in favor of economic growth. With obvious signs of May flickering in the economy and commercial war clouds on the horizon, it's no surprise that the PBoC is now starting to reverse the trend and adopt a more flexible policy despite the continuation of the deleveraging campaign.
The authorities remain reluctant to complain about the need for political relaxation and, at least publicly, are not yet ready to signal a decisive policy change. Market interest rates, however, give a clear verdict.
Two factors will be determining to determine the evolution of the PBoC law over the next few months. The first is whether the slowdown in domestic demand, especially on the consumer side, is accelerating before the support of the recent easing policy takes effect. The basic scenario of QNB is that the slight change in the current Chinese policy will continue and will succeed in placing a floor under GDP growth.
QNB expects further cuts in reserve requirements to boost banks' liquidity and PBoC against rising US rates. Modest easing measures should lead to a further decline in the CNY against the dollar, but they would not lead to a substantial devaluation.
However, if the downside risks to domestic demand and Chinese exports materialized, the decisively decisively defunct campaign and a more comprehensive easing of monetary policy, not to mention tax policy, quickly delivered.
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