China has a problem. Its short rates are too low and its long rates are too high.
Chinese short-term borrowing rates are too low, helping stoke a new stock bubble. Long rates are too high, thanks to surging government debt issuance. Meanwhile, private-sector borrowing is weak. What to do?
Facing a similar situation in 2009, the Federal Reserve embarked on large-scale purchases of long-dated government debt to ease borrowing conditions—so-called quantitative easing. Chinese central bank officials deny similar measures are needed, but local media report they are under consideration. Whether, and how, the PBOC goes about implementing them will be a major factor for markets in the year ahead.
China’s central bank isn’t contending with near-zero benchmark overnight rates, unlike the Fed in 2009. But China’s bubbly stock market is up nearly 20% in the past month. Lower short rates would make it even harder to prevent a stock-market bubble. It would also put pressure on China’s currency, just as the U.S. is closely watching for signs of deliberate yuan devaluation.
Moreover, Chinese short rates are already about as low as at the end of China’s previous easing cycle in late 2016. That still hasn’t been enough to spark a solid recovery. Chinese five-year government bond yields, however, are about 0.7 percentage point higher than back then—and rising again as stocks draw funds out of fixed income. To make matters worse, debt issued by the central and local governments is set to increase sharply, with planned municipal bond issuance alone about 1 trillion yuan ($149 billion) higher this year than last. Unless plentiful buyers materialize, government borrowing risks further crowding out the private sector.
All this is prompting some navel gazing. Caixin, the respected Chinese financial publication, reported in late February that officials have discussed how Chinese government bonds could be used in monetary policy and “have reached a preliminary consensus to take practices used in developed countries as a guideline.”
QE-like policies would be embarrassing, especially as China prides itself on having avoided Western countries’ post-financial-crisis flailing. But government-debt buying by the central bank might be preferable to another politically fraught way to help private companies: a U-turn on the continuing shadow-banking crackdown.
There are a number of QE-like programs that could—quietly—be expanded or tweaked, such as the central bank’s pledged supplementary lending program or its new targeted medium-term lending facility. These extend long-term central bank funding to banks, usually with government bonds as collateral. One problem is that the loans aren’t cheap: a one-year TMLF loan costs 3.15%, well above benchmark retail deposit rates of 1.5%.
Cuts to PSL or TMLF rates may be one signal that the central bank is moving more explicitly toward QE. Actual U.S.-style government bond purchases are less near term, but could rise up the agenda if China’s economy continues to stagnate. Either way, holders of Chinese government debt would add to their gains since last summer—at least until the current easing cycle ends.
Source: The Wall Street Journal