Blog

Assessing China’s “Structural” Monetary Policy

Policy will continue to be carefully calibrated as China walks a tightrope between supporting growth and maintaining financial stability.

The overarching economic goal of China’s leadership is to transform its old growth model to a more sustainable path, addressing the long-term challenges of an aging population, declining productivity and less and less room for policy stimulus. Ongoing policies such as rebalancing, deleveraging, and “Made in China 2025,” which are designed to achieve this transition, are likely to remain in place with some implementation details to be adjusted along the way.

“Dual circulation” economic strategy – adjusting to the changing geopolitical environment

China has recently unveiled a “dual circulation” economic strategy that is likely to be included in China’s upcoming 14th five-year plan (2021-2025) to guide the country’s economic policies. The idea is for China to rely predominantly on its domestic economic system (“internal circulation"), which will be supported by international markets (“external circulation”).  While some may view China’s long-term attempt to reduce its dependence on overseas markets and technology as reverting to a closed-door policy, we believe that it reflects a strategic adjustment in response to a more contentious geopolitical environment.

As U.S.-China tensions escalate and protectionism rises across the globe, foreign demand is becoming less reliable, so China is focusing on stimulating domestic demand to absorb its huge production capacity. China has, over the years, pursued and seen increases in final consumption and services as a share of GDP. However, industrial production remains a key contributor to the economy and the supply chain continues to involve critical links to imports and foreign expertise. With potential disruptions of global supply chains and less accessible foreign technology or key products, China’s policymakers see an urgent need to upgrade the country’s manufacturing sector, to develop a full-spectrum supply chain and to achieve technology self-sufficiency.  

Although a forced financial de-coupling remains a tail risk, we believe China will accelerate the internationalization of the renminbi (RMB) to mitigate potential disruptions of international transactions and further open its financial markets to foreign investors. Investors should expect some market volatility during this period of transition, and be more selective when choosing which sectors and asset classes to invest in.

China’s “structural” monetary policy aims to support the economy while avoid overheating

China’s increasing emphasis on employing targeted monetary policy tools reflects the central bank’s alignment with the government’s long-term agenda. The People's Bank of China’s (PBOC) “structural” monetary policy is essentially a set of differentiated policies that aim to optimise liquidity and credit allocation, to support key sectors and weak links in the economy, while avoiding bubbles and overheating in sectors such as real estate, industries that are experiencing overcapacity and shadow banking. We view this “precision irrigation” approach as walking a tightrope between supporting growth and maintaining financial stability. The country is facing high domestic debt and increasingly complicated macro-financial linkage, while the room for monetary stimulus is diminishing. Being mindful of the ultra-accommodative monetary policy in many developed countries in the aftermath of the global financial crisis and some of the side effects of its own massive stimulus in 2008-09, which led to surging debt, China has pursued a more prudent monetary policy over the past few years.

Examples of the PBOC’s structural monetary policy include a targeted and differentiated reserve requirement ratio (RRR) framework and the use of re-lending facilities to support small and medium-sized enterprises (SMEs). While this is an interesting experiment and diverges from conventional monetary policy, we believe it is important for the PBOC to strike a balance between targeted measures and market-based resource allocation, and to minimize unnecessary influence on market participants.

The PBOC took swift and pre-emptive monetary easing measures in early 2020 in response to an unprecedented national health crisis, but we expect monetary policy to become more balanced as the economy recovers. In our view, a near-term rate cut is unlikely, given China’s solid recovery, accommodative credit conditions, sizeable bond issuance despite higher yields, and the PBOC’s active approach to liquidity management. We expect the central bank to continue to implement more targeted monetary policies in favor of SME loans and medium- and long-term loans to the manufacturing sector.

Monetary policy will continue to be carefully calibrated

Should a super-V economic recovery occur in 2021, risk prevention will regain momentum. We would likely see credit tightening and fiscal tapering, further restrictions on the housing market, and a resumption of deleveraging. However, the bar for a policy rate hike will be high given the elevated debt in the economy and the government’s emphasis on maintaining financial stability. China will try to avoid over-tightening by encouraging better coordination among regulators.

In the medium-to-long term, we expect China to focus on promoting quality growth and controlling risk. Monetary policy will continue to be carefully calibrated depending on growth, reforms, and the external environment. Structural tools could be designed to support SMEs, industrial upgrading, technology development, effective investment, urbanization and environmental protection.

With China’s growth picture having relative cyclical strength versus other major markets, along with a sustainable monetary policy that provides a positive interest rate differential, we expect the Chinese currency to continue its appreciating trend and to attract portfolio flows. China onshore government bonds potentially should serve as a decent source of duration, which provides a favorable asymmetric profile with the PBOC having substantial capacity to cut rates if needed while near-term policy will be more balanced.  In addition, these bonds should provide potential portfolio diversification benefits as they gain wider adoption in bellwether indices.

The Author

Carol Liao

China Economist

Stephen Chang

Portfolio Manager, Asia

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

June FOMC Meeting: Flexible Expectations Targeting
XDismiss Next Article