In an effort to encourage investment within China, the government has further relaxed bank reserve requirements. It is another attempt to maintain the Chinese rate of economic growth to at least 7%. The latest industry wide cut, is the second one in less than 3 months. The last one was on February 04th, when a 50 basis points reduction was made. That was the first across the board decrease made since 2012. It highlights the determination of the Chinese leadership, to fight the economic slowdown that is now beginning to take hold. These endeavors matter greatly, given the large role that China plays in the international trade arena.
A Shanghai Branch Of Industrial And Commercial Bank Of China
The latest cut is the biggest single reduction in reserve requirements, since the global banking crisis of 2008. Although a number of analysts expected somewhat of a diminution, it was not on this scale. The Central Bank of China (PBOC) lowered the ratio for all banks by 100 basis points (bps) to 18.5%, effective April 20th. The hope is that it will encourage more bank lending in the world’s second largest economy.
First quarter growth for 2015 came in at 7% but barely. Declining industrial output and retail sales compounded by factory over capacity, are weighing the economy down. The slowdown in the overheated real estate market is accelerating in some areas of the country. This same sector is largely responsible for the large run-up in local debt, as more land was developed than was practical.
Golden Resources Mall, World’s Second Largest Mall
Despite the latest monetary efforts, China will soon experience the lowest rate of grow in a quarter of a century. The 7.4% rate of expansion for 2014, will not be possible for 2015 nor 2016. The objective now, is to at least maintain the present 7% expansion in GDP (Gross Domestic Product).
Although it is obvious that Chinese officials want lending to increase, they also wish for banks to reduce the amount of bad loans and to be profitable as well. As a result, Chinese bankers are reluctant to expand further credit to customers that are less viable. In the past, lending to corporations proved to be the best alternative to individual loans. However in the present economic environment, company executives are not inclined towards new investment, given weak internal demand and the over saturated global markets. This is combined with the weakening producer pricing power. Costs can no longer be simply passed on to the consumer. Domestic competition has become much more intense in recent years.
Factories In China
China is caught in the same dilemma as the other industrial powers are now in. One group of economists continues to call for more stimulus, while the other side insists that structural reforms is the only really sustainable path to economic growth.
It seems for now at least, that Chinese officials are looking for a quick fix. In addition to the overall cut in the RRR (reserve requirements ratio), there are further targeted ones. Local banks and cooperatives at the village level were allowed to reduce their RRR, an extra 100 bps bringing the total down to 17.5%. A further exception was made for the China Agricultural Development Bank. This major government lender was permitted an extra 200 bps step-down.
People’s Bank Of China Headquarters In Beijing
The Central Bank has also cut interest rates twice since November 2014, again to encourage more demand by lowering overall borrowing costs. Short term lending costs have certainly come down, but longer term lending continues to sputter. Real rates of interest in China have been higher than elsewhere in the industrialized world, so the Chinese do have some room for maneuver. The same is true for the RRR, with capital now flowing out of China, a cut in the RRR will help curb the risk of deflation and also maintain the monetary base.
The latest reduction in the RRR will in the mean time, provide a release of some 1.2 trillion yuan or the equivalent of $200 billion USD (United States Dollar). It has created a rally in stock markets in other parts of Asia, Europe and the United States. In China itself, there has been some stabilization in the stock markets which had taken a hit, when government regulators last weekend made it more difficult for investors to buy stocks with borrowed money. It also became easier to bet against stocks by selling short.
Shanghai Stock Exchange
Along with pumping the banks with added liquidity, the Chinese leadership is now considering buying up local government bonds. These in turn, can then be used as a type of collateral in offering low interest and long term loans from the central bank, to regional financial institutions of various types. This adds an extra impetus to get local banks to step up lending, which in turn would help foster growth. Or so that is how it is expected to work.
The problem lies in that these exact procedures of bond purchases, did not work well in Europe in restoring sustainable growth. Making all of these monetary practices the panacea for slowing growth in China alone, is quite nonsensical. The definite need for financial reform of the banks and state owned businesses continues to stall because of politics and cronyism. The reason why smaller firms and medium sized companies will not borrow money is that there is a lack of confidence, in the way the Chinese economy is now being managed. Therefore one can surmise that it is not the lack of credit which is preventing new investment, it is the lack of will.
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Many of these machinations to increase liquidity and access to credit will fail to deliver the desired result. The reason for this is that much of this new money will end up in the accounts of those individuals and companies that are part of the problem. Many of these companies are not competitive in a true open market and many local politicians will continue to divert funds into less productive enterprises. The state owned businesses are a perfect example of this. They continue to lose money, but are often allowed to go on regardless. They have become known as zombie companies.
There are early signs that the Chinese government may allow bankruptcy to become more common place. It is a needed market reform that will go a long way in forcing laggard businesses and companies to become more efficient. Of course, there is still anxiety about rising unemployment as the end result, of a larger concern becoming defunct. It is another version of the too big to fail model.
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The government of China promised back in 2013, that market forces would increasingly dominate the domestic economy. It is the only expeditious way, that the present distortions in the Chinese economy can eventually be dealt with. Yet, among the present leadership it seems far less controversial and more politically popular, to continue state sponsored stimulus of various kinds. True reformers understand what is happening, but continue to be overruled by more cautious leaders in greater authority. Rather than face the consequences of a steady misallocation of resources, it is far easier to start the next round of stimulus. That is until you at least run out of other options.