China roundup: Beijing dips deeper into its policy toolkit

March 31, 2015

It has been a very eventful month in China as Beijing dips even deeper into its policy toolkit as economic data continues to deteriorate. The economy is under threat from soft domestic demand and a general slowdown in economic activity, particularly in the housing market. This has resulted in cuts to interest rates and the reserve requirement ratio, but these moves haven’t had much of an impact on the real economy, at least according to post-cut economic data. Now, Beijing is using fiscal stimulus and easing housing restrictions on the top of monetary policy loosening in an attempt to spur economic growth and steam the deterioration of house prices.

At the beginning of March Beijing decided that it was restructuring the liabilities of local governments. The finance ministry announced that local governments, who are massively indebted, would be allowed to swap some of their crippling high-interest debts for cheaper-to-finance bonds. China did this by tripling the quota for bond sales by local governments to 1/1.5 trillion yuan.

Why is this important?

Short answer, China has a massive local government debt issue. Estimates of how much they owe are nearing 40% of GDP and the structure of this debt is unclear. In China, local governments can only borrow with the permission of the finance ministry, thus they seek out off-balance sheet lending. The decision to refinance to lower yield bonds significantly reduces this debt burden for local governments (the ministry estimates they will save 40-50bn yuan in interest payments this year), and while it reduces the amount creditors will receive, they are likely happy to swap that would-be capital for the security of these lower-yielding bonds.

Will it work?

Reducing the debt burden of local governments should theoretically free-up some cash, but this one event isn’t going signal a massive push for infrastructure spending from local governments. Instead, we consider this as a step in the right direction by using fiscal policy to support growth, alongside the PBoC’s loosening of monetary policy and the recent moves to ease property restrictions. It’s also another step towards eliminating the reliance of local governments on back-door funding, as it opens up the front door. As for how mush stimulus this move will provide, China’s fiscal deficit is expected to reach 2.7%, up from 2.1% last year.

Beijing softens its grip on the housing market

At the end of March Beijing announced moves to support its faltering property market. The PBoC cut the minimum deposit required on second-home purchases to 40%, which is down from around 40-50% in most cities and 70% in Beijing and Shanghai, and the finance ministry broadened a capital-gains exemption for home owners to include all those that have owned their property for at least 2 years – it was 5 years previously. These rules were in place to limit home flipping in China, which was partly responsible for the formation of a price bubble in the housing market.

China’s property market has been the backbone of the economy in recent times. It has sucked up huge amounts of resources and investment, making it the biggest contributor to GDP, thus a slowing property market has massive implications for the broader economy. Not only does it directly reduce investment, it also stifles confidence. This is why it is so important that China manage the property market and prevent a hard landing, and this month’s moves are another step in the right direction.

The yuan

Rumours have been building this month that the PBoC will move to widen the yuan’s trading band after a narrowing of the spot-fix gap. Around the middle of the month USDCNY reversed its upward trajectory without much warming. Admittedly, widespread US dollar weakness reinforced the pair’s downward push, but this happened after USDCNY began its decent. The likely reason is that the PBoC was/is attempting to fight the idea that the yuan is only heading lower this year amidst looser monetary policy and growing concerns about China’s fragile economic deceleration.

However, we aren’t entirely convinced that it is the right time for the PBoC to widen the yuan’s trading band. Chinese economic data continues to soften and there’s no guarantee that the USD’s rein of supremacy is over. Both of these factors are expected to help push USDCNY higher in coming months, albeit only slightly. (For a full rundown of on the yuan and the notion of a wider trading band see: Is the PBoC about to widen the yuan’s trading band?).

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