With the coronavirus wreaking havoc on Chinese and global economy, the People’s Bank of China (PBoC) has become the focal point of investors and policymakers worldwide.
As an early reaction to reduce stress in the market, the PBoC cut the one-year medium-term lending facility rate to 3.15% from 3.25% as markets opened first time after the Chinese New Year break, launched support programs to regions most hit by the coronavirus outbreak, and injected CNY200 billion of liquidity via MLF operations and CNY100 billion in funds through seven-day reverse repos.
Then on February 20, the 1-year Loan Prime Rate (LPR), which has become the official key rate in August, was lowered by 10 basis points to 4.05%. This was the fourth cut since August. The 5-year LPR was lowered by 5 basis points to 4.75%.
In addition to the monetary stimulus, Beijing promised more fiscal support including lower corporate taxes, despite a widening fiscal gap. The Chinese government pledged to cut unnecessary government spending to devote additional cash in areas most needed to fight back an eventual economic slowdown.
In economics, the word ‘stimulus’ refers to the use of monetary and fiscal policies to stimulate the economy.
Monetary stimulus measures include lowering the interest rates to allow corporations to borrow cash at lower cost to invest in new projects, but also liquidity injections via Open Market Operations and broad asset purchases program to insure a stable inflow and availability of cheap liquidity in the market to facilitate the circulation of money both in short, medium and long-term.
Fiscal stimulus involves cutting taxes and increasing government spending to boost economic activity and support growth.
In times of economic distress, central banks and governments often work together to obtain the best results, but it is not always the case. An efficient monetary stimulus generally necessitates a softer fiscal intervention and vice versa to avoid an overheating in the economy.
Why Chinese stimulus is so exciting?
The Federal Reserve (Fed), the European Central Bank (ECB), the Bank of Japan (BoJ) and other central banks have been deploying ultra-loose monetary policies since the 2007-2008 subprime crisis. While the Fed managed to uplift growth and inflation to some extent, the ECB and the BoJ’s efforts payed little.
The ECB has been running on negative deposit facility rate since 2014 to revive consumption and investment, but also to counter the negative blows of strict austerity measures posterior to the financial crisis on peripheral European countries such as Spain and Portugal. Yet, despite negative interest rates, European businesses prefer investing their cash in the market despite flat returns instead of financing new projects to boost growth. As a result, inflation and inflation expectations in the Euro area remain relatively soft and economic activity is subdued. In this sense, the European problem is difficult to solve with lower interest rates. As an alternative measure, the ECB deploys Targeted Long-term Refinancing Operations (TLTRO) to encourage companies borrowing cash, but the results remain weaker-than-ideal, as well.
In Japan, Shinzo Abe’s three-arrow stimulus package including massive monetary easing, fiscal stimulus and structural reforms didn’t pay off as expected either. Huge monetary expansion erased two thirds of Japanese yen’s value against the US dollar, but the first government attempt to increase consumption tax saw decent negative reaction and the so-called Abenomics finally resulted in a massive monetary expansion only; the other two arrows have been left aside until new notice. The Bank of Japan (BoJ) ultimately pulled its benchmark rate to -0.10% in 2016, but even negative rates didn’t get Japanese consumers to spend more, or Japanese businesses to invest more. The latest GDP data in Japan pointed at an economic contraction in the fourth quarter of 2019, and the data didn’t even take into account the potential negative spillovers of the coronavirus crisis.
As such, big economies such as Europe and Japan are far from getting out of the woods, while their central banks have increasingly less fire power to enact, faced with the unresponsiveness of their economies.
Under these circumstances, the PBoC’s stepping up efforts to give a decent shake to the Chinese economy is more than welcome, as China stands for more than 15% of the global growth and a boost in Chinese demand would benefit to economies globally.
Markets rally on China stimulus news
Even though the coronavirus crisis is too recent to translate into core economic data, the business surveys started giving an idea on how bad the economic sentiment and expectations have become in the Eurozone and elsewhere. Because the ECB, the BoJ and their peers are left with limited means to fight back another important economic crisis, the fact that the PBoC is taking responsibility for the coronavirus-triggered slowdown has given a relief to investors and policymakers worldwide.
A Chinese boost to the economy will certainly have positive spillover effects internationally. Therefore, what happens in China in the coming weeks and months matters the most to investors.
As such, the PBoC is about the become one of the world’s most watched central banks and its upcoming policy decisions will certainly have the power to move the markets in a way similar to big players such as the Fed, the ECB and the BoJ.