PBOC playing cool and calm as deflation specter rises

As 2024 gets underway, reasons to worry about China’s economy are almost too numerous to count: sub-trend growth, a deepening property crisis, falling exports, record youth employment and deflationary pressures.

As investors try to control the inclination to panic, it’s quite striking who isn’t: People’s Bank of China Governor Pan Gongsheng.

One expression of this calm is the PBOC’s avoidance of taking any assertive easing steps in recent months. An equally important one is the PBOC’s taking direct aim at recent yuan weakness.

By setting the daily reference rate for China’s currency at the widest gap to estimates since November, Pan pushed back at traders’ suspicions that Beijing might be angling to engineer a weaker exchange rate to boost exports. Nothing arguably would spur Chinese economic growth faster than following the Japanese yen’s downward trajectory.

The fact that Pan won’t pull the competitive devaluation trigger to boost exports, which newly released 2023 statistics show posted their first full-year decline since 2016, makes many wonder what the governor knows about the Chinese economy’s outlook that isn’t transparent to markets.

China’s exports shrunk 4.6% year on year, a reflection of economic weakness in its top trading partners. Exports to the US slipped by 6.9% in December from a year earlier, while shipments to the EU dipped 1.9%. Trade with regional partners including Japan, South Korea and Southeast Asia also fell.

Yet the idea that things might not be as dire as global investors fear is worth exploring given the conflicting signals emanating from Asia’s biggest economy.

Indications are that “the PBOC drew a line in the sand and defended the renminbi and, having defended key levels, the exchange rate now seems to be ticking higher,” says economist Louis Gave at Gavekal Research.

Gave adds that “simultaneously, most of the economic data seems to show that Chinese growth bottomed out in 2Q23. While China’s economy is hardly roaring back, the momentum is broadly, if meekly, pointing in the right direction.”

The implication here is that Pan is displaying confidence in efforts by President Xi Jinping and Premier Li Qiang to revive the economy without massive stimulus. And that the popular view that the property sector and other headwinds are a clear and present danger to China’s 2024 trajectory is overly negative.

The PBOC’s apparent calm also buttresses the view that China’s banking system is robust enough to withstand most shocks the global economy might send its way.

PBOC Governor Pan Gongsheng is exuding grace under pressure. Image: Twitter Screengrab

“We expect the authorities to continue a targeted credit allocation approach,” says analyst Elaine Xu at Fitch Ratings. This means “regulators guiding selected banks in channeling credit to strategic sectors, especially given the government’s focus on maintaining systemic stability and pushing forward risk resolutions at small and medium-sized banks.”

Yet Xi’s lack of bold stimulus comes with risks, including not least wider investor trust in the economy’s direction and management.

“The longer that China fails to show that it can recover, the likelihood that inflation expectations will decline in the West, as fears that China can export its deflation to the rest of the world through international trade will gain ground,” says strategist Thierry Wizman at Macquarie Bank.

The bigger implication is that “China’s deflation problem could be a welcome disinflationary restraint for the West,” Wizman notes.

Domestically, too, “the challenge for China’s economy in 2024 may be whether policies can mitigate deflation risks,” says economist Tommy Xie at Singapore’s Oversea-Chinese Banking Corp.

“If deflation risks persist longer than expected in 2024, China may resort to more aggressive easing measures such as interest rate cuts or restarting the Pledged Supplementary Lending program to expand the central bank balance sheet to boost aggregate demand.”

Odds are, Xi’s edict about not taking steps that encourage bad lending and borrowing decisions is trumping any desire at the PBOC to cut interest rates. Most likely, the PBOC remains linearly focused on using structural aid to accelerate Xi’s targets for “high-quality economic growth” over runaway stimulus.

“The possibility of broad easing has declined in the short term,” Zhao says.

Far from panicking, the PBOC is telegraphing something approaching confidence — one yuan fixing rate at a time. “The fix continues to convey PBOC’s desire for a stable yuan amid speculation of near-term monetary policy easing and fears of deflation,” analysts at Maybank write in a note. “Clearly, the central bank is not willing to loosen its grip on the yuan.”

The PBOC’s apparent avoidance of a race to the bottom on exchange rates with the Bank of Japan is also a favor to the global economy. A fresh currency war would destabilize the financial system, particularly amid what is expected to be a brutal election cycle in the US.

Nothing unites President Joe Biden’s Democrats and Republicans loyal to Donald Trump like a falling Chinese currency. It’s a trade-off, though, given the damage Chinese deflation would have on economies and multinational companies everywhere.

“No player is immune” to the forces of slowing Chinese growth, says Kevin Yin, analyst at JPMorgan Chase & Co.

There are risks, though, to Beijing not working faster to nip deflation expectations in the bud. The same goes for the slow pace of efforts to treat the root causes of China’s property crisis and create wider social safety nets to encourage consumers to save less and spend more.

“We think that officials are underestimating the extent to which China’s slowdown is structural in nature and won’t be so easily reversed,” says economist Julian Evans-Pritchard at Capital Economics.

Chinese policymakers seem unconcerned by growing signs of deflation. Photo: Facebook

Rather than target deflation, discussions in Beijing at the end of 2023 prioritized Xi’s belief that “technology self-reliance is more important” than ever, notes economist Ding Shuang at Standard Chartered. “I don’t see any signs of large-scale stimulus.”

This reform-over-stimulus crouch is a smart one in many ways. One of the top gripes about Xi’s 10-plus years at the helm is the slow pace of structural change, including reducing the role of state-owned enterprises to grow the private sector.

The lesson from Japan, though, is that once ingrained deflationary forces can be extraordinarily difficult to uproot. It hardly helps that China’s aging demographics is predisposed toward deflation as older people don’t tend to spend as much as younger generations.

Yet Pan’s PBOC may understand something the BOJ never did by sticking with two-plus decades of quantitative easing. The PBOC is going the other way by holding its monetary fire and projecting confidence that 2024 will be a better year for China than markets currently think.

Follow William Pesek on X, formerly Twitter, at @WilliamPesek