Stimulus Agenda:

At a time when central banks around the world are moving toward tightening their monetary policies to prevent the risk of rising global inflation rates, the Chinese economy (the world’s second largest) is moving toward adopting flexible monetary policies. In that framework, the decision of China’s central bank to reduce the required reserve ratio and bank interest rates and begin a new easing cycle for monetary policy comes at a stage when it has pledged to continue to maintain the application of stable macroeconomic policies, avoid taking excessive stimulus measures, and ensure the adoption of a soft monetary policy focused on supporting the real economy. This trend is due to increased expectations for a slowdown in China’s economic growth in the coming months, amid the ongoing supply crisis, the electricity crisis in China, and rising concerns over the potential repercussions of closures due to the outbreak of the Omicron variant, which may lead to lower GDP growth than the target of about 5% for 2022.

Pandemic Economies

In the first quarter of 2020, the Chinese economy witnessed a sudden collapse in demand and economic activity as a result of the spread of the Coronavirus. This led to a 6.8% decline in China’s year-over-year GDP, prompting the Chinese government to adopt the following economic strategies to contain the repercussions of the pandemic:

1. Launch of stimulus programs to confront the crisis: China’s central bank adopted an expansionary monetary policy to counter the repercussions of the Coronavirus pandemic. On March 13, 2020, it introduced a CNY 553 billion (USD 79 billion) stimulus program, along with a 1% reduction in the reserve, which contributed to providing CNY 55 billion of liquidity to the Chinese banking system. During the first quarter of the year, the Chinese central bank injected liquidity of CNY 1.2 trillion (USD 178 billion) and provided an estimated CNY 300 billion (USD 42 billion) worth of credit access for companies affected by the Coronavirus. The bank continued to stimulate the economy on April 3, 2020, by reducing the interest on excess reserves to 0.35% to encourage banks to expand lending, while the Chinese government approved a financial stimulus plan of USD 394 billion to combat the economic effects of the Coronavirus.

2. Tightening of monetary policies post-recovery: The Chinese stimulus program helped reduce the burden of the negative repercussions of the pandemic. In the last quarter of 2020, the Chinese economy recorded 6.5% growth, a strong indicator that the economy was starting to recover from the effects of the pandemic, outperforming other countries in the economic cycle over several quarters until the middle of 2021. This growth led to an early withdrawal of economic stimulus policies and the adoption of an economic tightening policy in the second half of 2021. On the financial side, policy was tightened by ending tax exemptions, reducing extraordinary social relief, and decreasing subsidies for public investments. On the monetary side, the injection of liquidity has declined markedly since the last quarter of 2020, and the growth of the M2 money supply fell to a rate lower than the growth of nominal GDP. This signals the adoption of a stricter stance vis-à-vis monetary policy in 2021. Moreover, the government initiated a comprehensive campaign to tighten control in the real estate and corporate sectors, which dampened business sentiment and led to a major recovery in private investments during that period.

3. Monitoring of real estate financing and consolidation of the debt instrument markets: Over the past two years, Chinese authorities have also adopted a stricter policy for providing ready financing to the real estate sector. During 2020, they developed three new criteria to which financial institutions and banks must adhere in lending to real estate companies, with the goal of promoting financial soundness in the real estate sector: the debt-to-cash-flow ratio does not exceed a certain ratio that has not been disclosed, as well as the ratio of net debt to equity, and the ratio of debt to total assets. This is tantamount to withdrawing the support provided to the real estate sector in a way that has increased the suffering of some real estate development companies in China, including the Evergrande Group, to which the Chinese banks have stopped lending since the beginning of 2021, causing it to default on its obligations, especially in light of the slowdown in its key activity due to the Coronavirus pandemic. Furthermore, the Chinese government has proceeded to consolidate the debt instruments markets by linking the interbank bond market and the bonds exchange, in a step aimed at consolidating the debt instruments markets, facilitating the flow of monetary policy, managing the macroeconomy, and allowing qualified investors to buy and sell bonds regardless of their trading market through infrastructure connectivity. By the end of 2019, the total outstanding bonds in China amounted to CNY 99.1 trillion (USD 143 billion), and the value of bonds in the intrabank market reached CNY 86.4 trillion, equivalent to 87.2% of that total.

Worrying Repercussions

The Chinese government’s strategy of withdrawing economic stimulus policies produced several worrying repercussions that prompted it to adopt supplementary monetary policies. These can be evaluated as follows:

1. Economic growth slowdown in the second half of 2021: The rate of Chinese economic growth declined to 4.9% during the third quarter of 2021, compared to 7.9% growth in the second quarter. This was the result of the rapid withdrawal of policy support and a delay in the resurgence of consumption, with a likely exacerbation of the situation due to the ongoing electricity shortage crisis, in conjunction with the spread of the Coronavirus pandemic and the ongoing supply crisis. The International Monetary Fund warned of a slowdown in economic growth in China and projected economic growth at a rate of 8% in 2021 and 5.6% in 2022.

2. Rising inflation rates: The year-over-year consumer price index in China rose by 2.3% last November, up from 1.5% in October 2021. Monthly inflation rose 0.4% in November, slowing from 0.7% in October, while producer prices rose 12.9% year-over-year, compared to an increase of 13.5% in October.

3. Adoption of a more flexible monetary policy: In the second half of 2021, China’s central bank tended toward adopting a flexible and appropriate monetary policy, prioritizing stability while maintaining reasonable liquidity, strengthening support for technological innovation, small businesses, and the manufacturing sector, enhancing efforts to improve the green financial system, and deepening financial reforms in key areas, through:

4. Stimulating lending by reducing its material cost: China’s central bank pledged to provide greater support for the economy by stimulating lending and decreasing its cost after reducing bank lending in February 2021 to CNY 885.8 billion (USD 131.81 billion), compared to CYN 3.23 trillion during January of the same year.

5. Promoting lending liquidity: China’s central bank seeks to encourage commercial banks to cut interest rates for lending. Thus, the required reserve ratio at the major commercial banks dropped 0.5 points as of July 15, 2021, with the goal of increasing the volume of monetary liquidity available for lending at banks by CNY one trillion (USD 154 billion) and supporting economic growth. The value of loans offered by Chinese banks during June 2021 reached CNY 2.12 trillion, exceeding expectations of CNY 1.8 trillion, compared to about CNY 1.5 trillion in May of the same year.

6. Cutting the interest rate: By the end of December 2021, China’s central bank cut the interest rate by about 3.8% for the first time since April 2020, compared to 3.85% in November. This came after the bank’s decision to reduce the amount of cash that creditors can maintain in their reserves, thus releasing about CNY 1.2 trillion (USD 188 billion) into the economy, while keeping the basic interest rate for greater than five-year loans unchanged at 4.65%.

7. Raising liquidity in the banking system: The central bank of China pumped nearly CNY 10 trillion (USD 1.56 trillion) into the Chinese banking system through seven-day reverse repurchases. It should be noted that reverse repurchases are the process through which the central bank repurchases securities from the commercial banks via offers to sell submitted by the banks with an agreement to resell these securities to the selling banks after the expiration of the period specified in the transaction, in this case seven days.

Agenda for 2022

The Chinese economy has slowed dramatically in recent months due to the domestic and global challenges facing the economy. Accordingly, economic policy-makers fear that China will encounter strong pressures leading to a decline in growth in the first half of the new year, given the challenges facing the global economy. In this context, it was decided to decrease growth expectations in 2022 to between 5% and 5.5%, compared to a 9.8% growth rate in the first nine months of 2021.

Chinese authorities set the priorities for economic work for 2022 during the Central Economic Work Conference. The People’s Bank of China pledged to continue to maintain the application of stable macroeconomic policies, avoid taking excessive stimulus measures, and ensure the adoption of a monetary policy focused on supporting the real economy. Meanwhile, analysts are predicting that the Chinese economy will see more monetary easing in 2022, through:

1. Consecutive rate cuts: Further cuts in the required reserve ratio at banks are expected, along with consecutive rate cuts in the coming months. The continued slowdown in real estate is likely to affect growth in the coming year, especially amid limited inflation pressures in China’s consumer prices. More structural policy tools, such as money re-lending or medium-term loans for financing facilities at low interest rates, are likely to be introduced soon to support selected regions, small businesses, and green projects.

2. Loans directed to serve sectors of the real economy: The central bank will focus on making financing better serve the real economy in 2022, which means maintaining stable credit growth so that money supply and total social finance increase at the pace of nominal GDP, improving the lending structure with more loans to small businesses and green or technology companies, and steadily reducing financing costs. Optimism about more central bank liquidity support has helped push 10-year bond yields below 2.8%, reaching the lowest level since June 2020.

3. Support for the real estate sector: The real estate sector is supported by strengthening oversight of capital companies and platforms, implementing a real estate finance management system by easing certain policies, and injecting money into banks to loan to small and medium businesses in order to guarantee that struggling real estate developers execute their projects. China’s central bank has issued instructions to the commercial banks, allowing them to increase liquidity by reducing the foreign currency deposit reserve ratio, after it had decided to reduce the legal reserve ratio against bank deposits in general. The central bank also called on banks to increase the pace of real estate lending to support struggling companies and increase the availability of liquidity to customers, in order to avoid the possibility of default.

4. Activation and development of the digital yuan: Chinese authorities seek to enhance the flexibility of the Chinese yuan exchange rate while keeping it essentially stable at a reasonable and balanced level and improving the market-based interest rate linkage. They do so in order to minimize corporate financing costs, strengthen macroprudential management, improve regulation of financial holding companies, and maintain a high level of pressure on cryptocurrency speculative firms. This coincides with the practical completion of tests to launch the digital yuan, with deals worth more than USD 5 billion. The digital yuan is expected to debut at the 2022 Winter Olympics in Beijing. The Chinese central bank seeks to improve cross-border payments, explore the potential for implementing cross-border central bank digital exchange, and expand the scope of pilot projects, while further improving the infrastructure of the digital yuan and enhancing the security and reliability of the system, in addition to establishing a relevant legal and regulatory framework.

5. Harmonization of financial policies: The Ministry of Finance announced it will proactively implement fiscal policies to achieve stable growth, stimulate the vitality of market entities, and deepen supply-side structural reform with a focus on facilitating the turnover of the national economy. Larger cuts in taxes and fees are expected in 2022, which will contribute to boosting demand and avoiding supply shocks, relieving pressures on the productive sector in general, and encouraging the small and medium-sized enterprises sector to expand and increase production. China has already allowed local governments to sell CNY 1.46 trillion in special bonds from the 2022 quota in order to accelerate spending early in the new year.

6. Expansion of institutional openness: This will be done by granting national treatment to foreign-funded companies, attracting more investment from multinational corporations, and facilitating the early implementation of major foreign investment projects, while taking a moderately proactive approach to promoting infrastructure investment and advancing the implementation of science and technology policies and innovation.

In sum, China’s annual Central Economic Work Conference has outlined the features of the economic policy for the new year, including raising the standard of living for citizens, achieving a stable macroeconomic policy, providing maximum social stability, continuing its commitment to introducing needed reforms, focusing on technological development and innovation as a key driver of economic growth, attending to the transition to diversified growth, and raising efficiency levels at work, in order to realize the maximum returns from increasing government spending. Although modifying Chinese monetary policy was urgently needed in order to achieve stable economic growth, the stagnation in economic growth could easily lead to systemic risks in the economy amid the ongoing economic slowdown. Thus, sound economic growth must be guaranteed in order to protect against economic risks. Since macroeconomic policy alone will not be sufficient to protect the economy from those risks, it is imperative that a greater number of systemic reforms be implemented to give all active forces in the economy, especially local governments, the appropriate incentives to respond strongly and actively to the expected stimulus and quantitative easing measures in order to maintain the stability of the overall financial leverage ratio in the economy, with the goal of achieving balance between supporting the overall recovery and preventing financial risks.