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China economy

Can China reduce debt and maintain growth, or is it mission impossible?

Releasing funds in response to economic growth headwinds could damage country’s financial situation in long term, analyst says

PUBLISHED : Tuesday, 26 June, 2018, 7:27pm
UPDATED : Tuesday, 26 June, 2018, 11:15pm

China is facing a mission impossible in trying to reduce its debt mountain while maintaining strong economic growth and a stable currency, analysts said.

The People’s Bank of China said on Sunday it would release US$100 billion into the banking system by allowing lenders to reduce their reserve requirements. The move is designed to support weak links in the economy and provide a cushion against any fallout from a possible trade war with the United States, but the “targeted” operation will not interrupt the government’s main aim to reduce debt levels, it said.

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Economists, however, said it will not be easy to cut debt – one of Chinese President Xi Jinping’s priorities – without hurting growth, especially with US President Donald Trump threatening massive tariffs on Chinese products.

“It is impossible to deleverage painlessly,” said Hong Hao, chief strategist with Bocom International, the brokerage arm of Bank of Communications, China’s fifth-biggest lender.

China’s central bank had to make a choice, he said. Its move towards easing in response to economic growth headwinds could come at the cost of worsening the country’s financial situation in the long term.

The central bank’s move caused China’s stock market to slump. On Monday, the Shanghai Composite Index fell 1.1 per cent to its lowest level in two years, while on Tuesday it ended down 0.5 per cent, sparking concerns it was moving into bear territory. The yuan also continued to weaken against the US dollar.

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Iris Pang, a China economist at ING, said her concern was whether the US$100 billion of liquidity the PBOC planned to release was enough to have a significant impact on China’s US$12 trillion economy.

“This may not be enough to cushion an escalating trade and investment war between China and the US, as well as a global trade war that disrupts the global supply chain,” she wrote in a note.

Hong said it seemed inevitable that the central bank would further cut lenders’ reserve requirement ratio – the proportion of funds they are obliged to deposit with the PBOC – following the 0.5 percentage point reduction planned for July 5.

“Few options are available for policymakers, and all the cards have been on table,” he said. “More cuts this year are inevitable.”

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The country’s biggest lenders, including Industrial and Commercial Bank of China and China Construction Bank, are set to see their collective available funds rise by about 500 billion yuan as a result of the central bank’s move. Most of the money is expected to be used to finance debt-to-equity swaps, which have been encouraged by Beijing as a way to bail out troubled state-owned enterprises.

Smaller banks will benefit to the tune of about 200 billion yuan, the bulk of which they have been told to make available as financing for small businesses.

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It is not uncommon for China’s central bank to use monetary policy as a tool to finance whatever industries or sectors it feels need it. However, lenders do not always adhere to its plans, and are generally more interested in funding property and infrastructure projects.

Fan Ruoying, a researcher at the Bank of China’s Institute of International Finance, said that was unlikely to change.

“The money tends to flow to the property market … based on previous experiences,” she wrote in a note.