If Governor Yi Gang’s staff at the People’s Bank of China had been planning a vacation in 2023, it might be time to cancel.
The PBOC’s surprise move on March 27 to lower the reserve requirement ratio (RRR) for financial institutions by 25 basis points is the first official acknowledgment that troubles from Silicon Valley Bank (SVB) to Credit Suisse are a clear and present danger to China’s 5% economic growth target.
What’s more, it signals the start of a wider effort by Beijing to get out the economic sandbags.
Already there are hints that consumption isn’t shooting skyward as fast or as sharply as hoped since President Xi Jinping scrapped “zero Covid” lockdowns. Yet intensifying headwinds from the West is the last thing Yi needs right now.
When Yi learned that Xi would be keeping him on at the PBOC, further monetary easing probably wasn’t in the cards. Yi’s full attention needed to be on recalibrating monetary policy carefully to resolve China’s property market issues.
That meant providing just enough targeted liquidity to avoid defaults, but not so much as to enable fresh leveraging activity. That balancing act is now taking a backseat to stabilizing China Inc as a whiff of 2008 returns to global markets.
“This will provide a bit of financial relief for China’s large and medium-sized banks,” says economist Julian Evans-Pritchard at Capital Economics. “It may also help nudge down lending rates slightly. But given the wider signs of policy restraint, we doubt it will have a significant and lasting impact on monetary conditions or credit growth.”
Economist Jacqueline Rong at BNP Paribas SA adds that “the wobbles in interbank liquidity have increased as early signs show loan-making into March continues to be robust and issuance of special local government bonds is also likely to pick up pace in March and April.” As such, Rong reckons the PBOC may lower the RRR another 25 basis points in the second half of 2023.
Though the explanations for SVB’s collapse are many — including terribly timed deregulation moves in 2018 — the US Federal Reserve’s fingerprints are the most prominent on this financial crime scene.
First, Fed Chairman Jerome Powell cut interest rates in 2019 when the US didn’t need stimulus, bowing to political pressure. Then Team Powell was too slow to act in 2021 to address surging inflation, betting it would prove “transitory.”
In 2022 and early 2023, the Fed played catchup by engineering its most strenuous tightening cycle since the mid-1990s. The resulting surge in the dollar sent Asian currencies lower, leaving economies vulnerable to high energy and food prices.
The jump in US bond yields destabilized SVB, too. Granted, poor corporate governance at the bank left it susceptible to rising rates. But the cumulative blow from aggressive Fed rate hikes has mid-size and regional banks that failed to hedge against them on the verge of failure.
That market turbulence is now shaking up Asia in ways the PBOC could do without. Then again, the SVB and Credit Suisse stumbles are proving less of an immediate threat to Chinese banks than Japanese lenders.
Last week, Japan’s three leading lenders – Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group – lost more than $20 billion in market value. China’s big four state-owned banks gained more than that — roughly $30 billion in Hong Kong and Shanghai markets.
One reason: for years now, Japanese banks focused more on buying bonds than making loans. They both weakened the Bank of Japan’s monetary firepower and left the nation’s lenders more vulnerable to rising yields.
A month ago, the chatter was about the BOJ ending quantitative easing. Now that prospect is essentially off the table. And the timing of this timidity could not be worse. Thanks to a weak yen, Japan is now importing the worst inflation in 41 years.
Yet China’s PBOC faces its own daunting challenges. Not least of which is the banking troubles in the West.
Already, says economist Steven Cochrane at Moody’s Analytics, signs were that “China’s recovery will be gradual with a slow acceleration of consumer spending and investment expected to lead the way.” And now, he adds, this “new risk has emerged as financial conditions tighten following the failures of Silicon Valley Bank and two other regional banks in the US.”
China’s housing market, Cochrane says, “may add some heft by the second half as liquidity is directed to developers so that stalled projects can be completed. Manufacturing for exports is the wild card in China’s outlook and depends upon the stability of demand from North America and Europe.”
But banking troubles in the West are now a huge wildcard. They have complicated Yi’s ability to get the right mix of support and austerity to achieve the big goals the Communist Party put forth at the recent National People’s Congress. There, party leader Xi’s team unveiled a raft of supply-side reforms that hinge very much on Yi’s ability to squeeze excesses out of Asia’s biggest economy.
In order to keep reforms on track, expect Yi’s team to stay active with monetary tweaks here and there.
Recent PBOC steps, says economist Tan Kai Xian at Gavekal Research, are “mostly meant to keep liquidity from tightening more than intended, as interbank interest rates have stayed above their policy benchmark in recent weeks. But it could also be in part a preemptive move to keep global financial strains from disrupting the reopening. China’s government isn’t doing massive stimulus, which doesn’t look necessary, but supporting the recovery is the top priority.”
Lauren Gloudeman, analyst at Eurasia Group, says the surprise RRR cut “raises several possibilities. It may be intended to reassure markets and firms that Beijing is committed to delivering economic recovery after the conservative outlook stimulus presented at the National People’s Congress led to a downgrading of consensus expectations for growth relative to more optimistic views about reopening expressed earlier this year.”
These factors, Gloudeman says, “upgrade expectations for additional small-scale RRR cuts in the first half of the year until signs of economic recovery are more apparent and unless inflationary pressure increases meaningfully.”
These inflation risks are no small challenge for the PBOC. All of which helps to explain why Yi retained his job at the recent NPC, when Xi might have opted to clean house at the PBOC. In March 2018, Yi succeeded the globally respected Zhou Xiaochuan, who retired after 16 years helming the PBOC.
Zhou was a hard act to follow. Along with straddling three governments – those led by Jiang Zemin, Hu Jintao and Xi – he oversaw one of China’s most impactful reform moments. That was in 2016, when Beijing secured a place for the yuan in the IMF’s top-five currency club along with the dollar, euro, yen and pound.
Once inside the IMF’s basket, China had no choice but to increase transparency and liquidity as it put the economy on a path toward increased convertibility. Zhou was often at the discussion table when China negotiated moves to open a range of channels for foreign investors to access Chinese stock and bond markets.
Mainland shares have since been added to the MSCI index, while government bonds were included in the FTSE Russell benchmark.
As economist Otaviano Canuto at the Brookings Institution argues, the “qualitative leap towards the internationalization of the Chinese currency as a full reserve currency will only happen when confidence in its convertibility is sufficient” to convince central banks and investors to hold yuan.
Equally important, keeping yuan internationalization on track means getting the cart-and-horse dynamic right. In recent years, Xi’s team has largely pursued a size-matters-most model of building credibility in currency markets. It’s been slower, though, to do the heavy lifting on reforms needed to garner trust organically.
That means removing all currency controls and allowing for full convertibility, building a more credible credit rating system and allowing for the dissemination of news and data germane to becoming a world-class financial destination.
The more successful Yi is at raising China’s financial game in the background, the more latitude new Premier Li Qiang’s reform team will have to give the private sector space to grow and compete. That’s particularly so of a tech sector that’s been under regulatory assault since late 2020.
As these machinations take place, though, the PBOC is signaling “the new government’s desire to send a pro-growth signal and perhaps to be extra cautious on liquidity management amid significant banking stress overseas,” says Goldman Sachs China economist Hui Shan.
Yet Yi also has his work cut out to ensure that the deleveraging efforts that began on Zhou’s watch stay on track. As economist Wei He at Gavekal Research points out, the “sweeping overhaul” of China’s regulators unveiled this month has the PBOC ceding some authority to the top political leadership and other regulatory agencies.
“Although the leadership clearly remains concerned about financial risk, particularly at the local government level, the focus is now on a less aggressive approach of restructuring debts to avoid market stress,” He says.
The worry, of course, is that China risks losing momentum in prioritizing the quality of growth over the quantity. Protecting progress made so far would be easier if the PBOC didn’t have to respond to the SVB and Credit Suisse troubles spooking world markets.
Suffice to say, there won’t be many vacations approved at PBOC headquarters this year.
Follow William Pesek on Twitter at @WilliamPesek