Small, bold moves from the PBOC
21 March 2017
Somewhat overshadowed by the headlines emanating from the National People's Congress, Chinese data covering first few months of the year have showed unexpectedly strong momentum. This has defied some of the predictions that the economy would begin to weaken early in the year amidst a monetary tightening-induced housing slowdown. In addition to the widespread forecast upgrades from global investment banks, it has also given the PBOC enough confidence in underlying fundamentals to further increase interest rates. While much of the attention has been paid to the PBOC "following the Fed", we feel that Fed rate hikes are just one reason why the PBOC is raising the repo and lending facility rates. Yes, keeping a stable rate differential is an important central government policy priority (see Chart 10), especially given how much importance policymakers have placed on attracting foreign investors into the domestic bond market. They see a stable yuan as being necessary to attract inflows and most indications are that this will continue to be a high priority throughout the year. However, the tightening also reflects the PBOC's desire to enact countercyclical monetary policy to lessen the risk of overheating. This appears justified given the recent housing market data showing surging house price growth despite the earlier tightening measures that had been put in place.
Keen to curb asset prices bubbles and guard against financial risks, especially around rising house prices and elevated commodity prices, the PBOC is clearly signalling its intent to tighten policy and reduce liquidity. However, it is important to keep in mind that the PBOC is not an independent central bank, and while it might want to tighten to fulfil its professional obligations, it still has to respond to the views of the central government. Hence, the PBOC is tinkering with liquidity tools while leaving benchmark rates untouched (see Chart 11). This lack of independence is likely a key reason why the PBOC has so quickly reformed its policy tools and framework. The numerous tools established over the last two years to guide short-term interest rates were an attempt to move away from a clumsy framework relying on fixing lending and deposit rates, but also to gain some semblance of independence; any changes to "policy rates", reserve requirement ratio (RRR) or benchmark lending/deposit rates require central government approval. But the new lending facilities do not. Using these facilities instead of benchmark policy rates allows the central bank to exert more control over monetary policy and react to economic instead of political pressures. This interpretation was bolstered by the explicit language used in the PBOC's recent statement discouraging the interpretation of the recent rate increase as a "policy rate hike" as it gave it scope to adjust rates without running afoul of the official policy stance of "stable and neutral" monetary policy. However, it also raises numerous questions, including whether tighter liquidity on the interbank market affects lending to the real economy. Data on the distribution of bank loans by lending rates is only available until Sept 2016 so it is too early to know the impact. Over the longer term, it is also unclear how these tools will fit into a broader, transparent monetary policy framework. Moreover, if and when growth begins to slow, it is unclear if the central government will choose to exert more control over these new tools. Only time will tell, in the meantime the PBOC is quietly gaining some independence.
Alex Wolf, EM Economist