Debate in China on quantitative easing heats up as growth slows
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A debate over whether China’s central bank should directly bankroll state spending is flaring up among bureaucrats and economists in Beijing as the Chinese government is under growing pressure to find new ways to arrest a deepening economic slowdown.
The debate was initiated by a middle-ranking official at China’s Ministry of Finance, who argued in a speech at a bond forum last week that the People’s Bank of China (PBOC) should use treasury bonds as a major monetary policy tool and make the government bonds “quasi-money”.
Guo Fangming, the deputy director general of the finance ministry’s treasury department, said China would look into ways to link “treasury bond management and monetary policy”, a suggestion that would blur the lines between monetary and fiscal policies to produce a China-style quantitative easing policy.
While there is no evidence that the Chinese leadership will endorse his idea and it is technically illegal in China for the central bank to bankroll state spending directly, Guo’s suggestion reflects a looming crisis for the Chinese leadership – Beijing’s traditional way of pumping liquidity into the banking system is not working as effectively as expected to bolster economic activity.
Xu Gao, an economist with Everbright Securities, wrote in a research note this week that the idea of asking the central bank to buy bonds, or even stocks, was a replica of the US Federal Reserve’s actions in 2002 under then-chairman Ben Bernanke.
“It’s basically the ‘helicopter money’ idea from Bernanke,” Xu wrote.
“The conventional monetary policy transmission mechanisms are not working … there are reasons to argue for the central bank to adopt non-conventional measures.”
In fact, the Fed, the European Central Bank and the Bank of Japan all adopted similar approaches to boost their economies after the global financial crisis of a decade ago.
Under quantitative easing, the central bank buys bonds created by the government, in effect creating new money that goes into the financial system in an attempt to boost lending and economic activity.
But it is a taboo in China, which had its fingers burned in the 1990s when it allowed banks to bankroll state spending.
The resulting mess caused China to attach a clause to its central banking law which banned the PBOC from buying any government bonds.
The only exception has been its US$200 billion special bond purchase in 2007 that was used to set up the China Investment Corporation, the country’s flagship sovereign wealth fund.
At the same time, the scattergun approach to stimulus that quantitative easing represents is exactly what the central bank wants to avoid.
Instead, the central bank has to date used a targeted approach to ease monetary policy, aiming in particular to boost lending to small and medium-sized businesses, which have been hit hardest by the trade war.
The problem, analysts say, is that the large amounts of extra liquidity the PBOC has injected into the banking system are not being lent out in sufficient quantity.
Rather, because of residual concerns about credit quality due to the government’s campaign to reduce debt and risky lending, banks are instead buying bonds in financial markets with the extra money instead of aggressively seeking new borrowers.
Xie Yaxuan, chief macro analyst of China Merchants Securities, said the calls for quantitative easing reflected the existing dilemma faced by Chinese policymakers.
Although the central bank has injected trillions of yuan worth of liquidity – through its daily operations, cuts in the amount of reserves banks must hold at the central bank, and low-cost lending to banks through its medium-term lending facility – the difficulties of smaller private-sector firms in getting access to credit – and the cost of that credit when they can access it – remain largely intact.
“The problem can’t be solved by just loosening monetary policy,” Xie warned. “Since there is already lots of liquidity in the interbank market, further large-scale easing could be harmful.”
Ming Ming, chief fixed-income analyst of Citic Securities, said Beijing did not need to use quantitative easing at this stage.
“Such large bond purchases would have a huge impact on the market unless interest rates approach zero,” he wrote in a research note.
Sun Guofeng, who oversees the PBOC’s monetary policy department, said the central bank would be cautious of the distortion and risk caused by a scattergun approach.
Instead, he said, the PBOC would seek to make existing monetary easing more effective by improving the policy transmission mechanism.
“The monetary and financial conditions must match the need for steady economic growth and stable consumer prices,” he wrote in an article published by China Finance magazine on Monday.
Sun said credit supply was now constrained by banks’ capital adequacy level, market liquidity and the two-track interest rate mechanism for lending and borrowing rates.
“[We] will use market incentives to encourage bank lending to the real economy, rather than quota allocations and other administrative orders,” Sun added.
The argument between the ministry of finance and the central bank harks back to the early 1990s when the finance ministry relied on the PBOC to buy its treasury bonds to raise construction funds, but inflation crept up due to excess monetary loosening.
The focus of their debate has now shifted to who should take greater responsibility for economic stabilisation.
Last June, Xu Zhong, research chief of the central bank, openly questioned the size of the governnment’s “proactive” fiscal policy – led by the finance ministry – given the nominal budget deficit was at a six-year low of 2.6 per cent.
At a seminar last week, veteran government adviser Wu Jinglian pointed out Beijing had a history of relying on expansionary monetary policy to solve economic problems.
Referring to the money printing which occurred ahead of the party congress in 1987, the 89-year-old economist said it had contributed to the failure of the merger of two-track pricing mechanisms.
“Using expansionary monetary policy to support high [economic] growth is a problem which remains unsolved,” he said.