Analysis: China’s Monetary Measures Overlook Key Threat to Economic Growth By Reuters

By Liangping Gao, Ellen Zhang, and Marius Zaharia

BEIJING/HONG KONG – China’s central bank has adopted a more aggressive approach to easing monetary policy, yet it seems to overlook the primary challenge facing economic growth: consistently weak consumer demand.

The liquidity measures and reduced borrowing costs announced by the People’s Bank of China have improved market sentiment, primarily because they bolster expectations that authorities will soon introduce a fiscal package to strengthen monetary and financial efforts.

As the world’s second-largest economy grapples with significant deflationary pressures, it risks falling short of its growth target of approximately 5% for the year due to a sharp downturn in the property sector and declining consumer confidence. Analysts contend that only fiscal policies aimed at putting money directly into consumers’ hands, such as increased pensions and social benefits, can effectively address this issue.

"The central bank’s policies surpassed expectations, but the core problem in the economy today is not a shortage of liquidity," stated Shuang Ding, chief economist for Greater China and North Asia at Standard Chartered. "To support the real economy, I anticipate another policy package, particularly focusing on fiscal measures."

HSBC’s chief Asia economist, Fred Neumann, agreed, emphasizing the need for authorities to bolster demand, which could be achieved through various policy measures, including fiscal initiatives.

While the People’s Bank of China is implementing its most substantial measures since the onset of the pandemic, the overall size of the stimulus appears minimal, casting doubt on its potential effectiveness. Given the weak credit demand from both households and businesses, the 1 trillion yuan (about $142 billion) injected into the financial system due to reduced bank reserve requirements might lead to more buying of sovereign bonds rather than lending to support the real economy.

According to the China Beige Book, firms have been reluctant to borrow regardless of favorable credit conditions due to poor corporate sentiment. Similarly, households are unlikely to become notably more optimistic in response to lower returns on savings.

The reduction in existing mortgage rates is anticipated to free up an extra 150 billion yuan annually for households. However, this represents only 0.12% of annual economic output, and some of the savings may be redirected toward earlier mortgage repayments.

Evidence suggests that Chinese consumers typically spend only 35 yuan of every additional 100 yuan they receive, as estimated by Raymond Yeung, chief Greater China economist at ANZ.

The recent cut in the key interest rate by 20 basis points, though relatively large, is still smaller than reductions typically enacted by most central banks, such as the 50 basis points cut by the U.S. Federal Reserve last week.

According to analysts from Gavekal Dragonomics, the central bank’s primary monetary policy measures have been previously employed and had minimal impact on the economy. They characterize the scale of the current package as modest, noting that its significance largely hinges on whether it paves the way for further actions.

MORE STIMULUS?

By infusing liquidity, the People’s Bank of China is creating more leeway for the government to issue debt for any forthcoming stimulus, Neumann noted. Market expectations are that these liquidity measures may herald an announcement in the coming weeks regarding substantial bond issuance.

Lynn Song, chief economist for greater China at ING, emphasizes that increasing government investment is the most immediate way to stimulate the economy, although there is a growing inclination among economists towards demand-side support, which could materialize through consumption vouchers or similar initiatives.

Historically, investment has been the go-to option. In October of last year, to achieve the 2023 growth target, Beijing unveiled an additional 1 trillion yuan in special treasury bonds to finance various infrastructure endeavors.

However, it remains unclear how distinct any additional stimulus this year would be. Officials previously signaled a slight shift in spending towards consumers in July by subsidizing purchases of new appliances and other goods, a small step toward addressing the long-voiced concerns regarding the disparity between investment and consumption.

Household consumption accounts for roughly 20 percentage points less of annual economic output than the global average, while investment—driven by government and fueled by debt—is approximately 20 percentage points higher.

This imbalance might be rectified through state transfers to consumers. Analysts from Nomura suggested that Beijing could increase pensions and medical benefits for low-income groups and provide childbirth subsidies to begin rebalancing the economy. However, they caution that such measures may not be implemented in the near future.

"We believe that monetary and financial policies alone cannot stem the ongoing economic downturn," they concluded, underscoring the need for fiscal stimulus to take precedence while advising investors to temper their expectations.