South China Morning Post
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Construction workers are seen at the Gaolan Harbour Interchange, part of the Hezhou-Gaolan Port Highway project in Guangdong province, on May 5. With growth flagging and the yuan weakening against the US dollar, pressure is growing on Chinese policymakers to enact an intensive investment spending campaign. Photo: Xinhua
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

China must end its monetary policy easing cycle and raise interest rates to stabilise the yuan

  • Beijing needs to allow fiscal stimulus to carry the burden of economic regeneration to stay on its 5.5 per cent growth track
  • Rather than reckless expansion, China needs an intensive investment spending campaign to boost domestic growth and ease market fears
David Brown
David Brown
Why you can trust SCMP
Is this the end of the road for China’s easing cycle? The US Federal Reserve has thrown down the gauntlet against rising inflation risks with a commitment to tougher half-a-percentage-point interest rate increases for the foreseeable future.
This will make it doubly difficult for Beijing to cut domestic interest rates again without endangering exchange rate stability for the renminbi and running the risk of another row with Washington over concerns about China being a currency manipulator. The renminbi is in sharp decline against a resurgent US dollar, and there is also the problem of domestic inflation risks increasing.
With global interest rates pushing higher, Beijing needs to switch the emphasis of monetary policy away from easing to a tightening bias fairly soon. It must allow fiscal stimulus to carry the burden of economic regeneration to help the government stay on track for its goal of 5.5 per cent growth in 2022.

In the past few weeks, the renminbi has lost about 5 per cent of its face value against the US dollar. Global investors are weighing the relative risks of China easing interest rates again while the Fed has stepped up its tightening campaign by signalling its intention to move more aggressively against inflation.

After last week’s half a point increase, the benchmark Fed funds rate has moved to 1 per cent. The general perception is that it could be heading towards 3 per cent or higher in this tightening cycle.

The People’s Bank of China (PBOC) last cut its benchmark one-year loan prime rate by 0.1 per cent, to 3.7 per cent, in January. It has kept the cost of borrowing on a downward track by recently lowering the reserve requirement ratio for banks by 0.25 percentage points.

The perception that China’s interest rate differential over the United States will continue to narrow is worrying investors, especially when global risk assets are under pressure and the US dollar is in such strong demand as a safe haven.

In any case, the PBOC should have negligible scope to ease, especially with China’s consumer price inflation rate forecast to hit 1.9 per cent for April, up from 1.5 per cent in March.

Headline inflation still has some way to go before it hits Beijing’s 3 per cent target, but monetary policymakers cannot afford to be seen lagging behind while inflation risks are surging around the world.

Any semblance of benign neglect will not go down well with currency markets. It will become an uphill struggle for Beijing to keep monetary policy on an easing trajectory while US interest rates are heading higher, the relative rate gap is converging, and the renminbi is under increasing pressure.

A weaker exchange rate and higher import costs will make it even more difficult for Beijing to keep a lid on domestic price rises.

With the US dollar-renminbi exchange rate already back beyond 6.7, the last thing Beijing needs is for dollar bears to set their sights on a return to the pre-pandemic peak of close to 7.2 in September 2019. That could effectively blow the government’s 3 per cent inflation target out of the water.

The best option would be to bring China’s easing cycle to an early end and switch the focus to fiscal reflation. Beijing should avoid mimicking Western-style monetary expansion with interest rates that are too low and aim to steady the exchange rate with an implied tightening bias ahead.
The yuan is in sharp decline against the US dollar, raising concerns about Chinese monetary policymakers bringing an early end to the country’s easing cycle. Photo: Shutterstock
Instead, Beijing can afford to go on an intensive investment spending campaign to turbocharge domestic growth prospects. It should suspend its commitment to fiscal stability for the next few years until China is out of the woods on the pandemic and the global cost-of-living squeeze has passed.
Beijing must marshal its domestic resources to accomplish 5.5 per cent growth this year rather than throw caution to the wind with ultra-cheap money, hoping that consumers and businesses will take up the slack instead. It needs to maintain a healthy interest rate and bond yield differential to the US to ensure exchange rate stability is maintained.

China’s interest rates need to go up, not down. It would mean a bigger government deficit, possibly approaching 5 per cent of GDP this year from the expected 2.8 per cent, but the benefits for faster growth would be worth the effort.

David Brown is the chief executive of New View Economics

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