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China's monetary policy easing

February 2019

China's radical experiment

China's attempts to boost lending are becoming bolder by the month.

China is throwing everything at its economic problems.

As weaker exports drag the country's growth to the slowest annual pace since 1990, the People’s Bank of China has implemented no fewer than 15 measures in the past four months alone to stabilise the economy. These include a series of reductions in banks’ reserve requirements, or the amount of cash that banks must hold as reserves against lending.

That’s still not enough, however. Credit is not quite flowing where it’s needed – Chinese lenders don’t have sufficient capital to lend to households and smaller companies - so the PBOC believes it needs another weapon.

This is why it has launched a new programme that will allow banks to issue a type of funding instrument popular in other countries – perpetual bonds. Such securities, which have no maturity date and rank lower in firm's capital structure than senior bonds, are a useful funding tool for banks as they count towards their non-core 1 tier capital, the gauge regulators use to measure a financial institution's health. 

Through its Central bank Bills Swap (CBS) programme, the PBOC will allow primary dealers of perpetual bonds issued by banks to swap them for high-quality central bank bills. At the same time, perpetual bonds sold by banks with a rating equal or higher than AA will also become eligible collateral for the PBOC's broad suite of funding facilities.  

It’s a bold move. While the PBOC is not quite engaging in quantitative easing, it is essentially re-capitalising the banking system by taking riskier subordinated debt onto its balance sheet.

Its calculation is that this should help unclog the credit transmission channel and spur lending in the private sector, which contributes more than 60 percent to national output.

Banks are sure to take up the PBOC's offer. A few days before the CBS programme was launched, the Bank of China, a state-owned commercial lender, announced plans to issue as much as RMB40 billion in perpetual bonds, the first of its kind issued by a Chinese bank.

The sheer scale of the PBOC's stimulus could have a major bearing on the global economy. Tallying up its various monetary measures, including asset purchases and its regular open market operations, China now accounts for more than half of the liquidity being pumped into the global financial system, compared with less than fifth a decade ago.1 According to our calculations, the supply of liquidity from the PBOC will have reached a record high in January (see chart).

But we don’t think the central bank will stop here. At the very least, we expect the PBOC to cut banks’ reserve requirement ratios by a further 150-200 basis points this year.

If the Chinese backstop succeeds in arresting a domestic and global slowdown, the old investment adage of “Don’t fight the Fed” might have to be supplanted by “Don’t fight the PBOC”.

Getting more liquid
China's central bank liquidity injection approaching record highs
China's central bank liquidity injection

Policy liquidity flow calculated as central bank liquidity provision (regular open-market operations, large-scale asset purchases, repo operations) net of sterilisation (reverse repo operations, reserve requirement ratio adjustment) on a 6-month rolling period, % of GDP. Source: Thomson Reuters Datastream, Pictet Asset Management; Data covering period 31.12.2008-31.01.2019.