Chinese policy: finding right weapon

China is going through a very awkward transition period. It is not only trying to rebalance the economy, it is also trying to improve the allocation of capital through the reform and anticorruption campaign. Hence, it is avoiding a replay of the 2009 stimulus when significant infrastructure spending and surging lending to State Owned Enterprises and other wellconnected entities quickly restored growth.

The current approach combines monetary easing and targeted fiscal policy. China has inniciated number of small policy changes. The country has accelerated infrastructure project approvals and taken various funding sources to speed up investment growth, such as utilizing idled fiscal funds, leveraging up policy banks, spurring local government debt swaps and promoting Public Private Partnerships. In additional to interest rate and RRR cuts, the PBoC has become more flexible in terms of managing liquidity, using its open market operations and various relending facilities. Most recently, the government has introduced measures that simulate demand for auto purchases and in the housing market.

China has cut the reserve requirements of banks modestly, but these are still well above historic norms. PBoC is likely to cut at least 50bp, foresees Bank of America ML. The one-year lending rate has dropped from 6% in 2014 to 4.6% most recently. However, with CPI inflation of about 2%, real interest rates seem a bit high. Our China team expects one or two 25bp cuts to come. While a big fiscal stimulus is unlikely, China can also do more on the fiscal front. 

"The exchange rate will play a small role in the efforts to revive growth. All of this suggests a more careful approach in the coming months. Claudio Piron, our regional currency strategist, expects a further 5-10% depreciation over the next 12 months, with the Renminbi ending this year at USD/CNY 6.50 and next year at 6.90. That should provide marginal support to the economy as part of a broader stimulus effort", says BofAML.