Opinion     

Implicit tightening aims at deflating credit bubble

Shanghai Daily, July 16, 2013

• China's financial markets have been experiencing tighter liquidity as a result of deliberate government policy.

  Tighter liquidity is, in effect, tighter monetary policy. Economist Milton Friedman believed that the best way to judge monetary policy is not by the inputs, such as the monetary policy rate, but by outputs, such as growth and inflation. This is because expectations of future policy settings, which are harder to measure, play a bigger role in driving aggregate demand than current policy settings.

  Managing expectations is important. Chinese economic policy has shifted since the new leadership took over in late 2012, with a noticeable de-emphasis on GDP growth. President Xi Jinping has stated that local government officials should not be judged solely on GDP growth.

  Expectations that the government is willing to let growth fall below trend is arguably more concerning than the liquidity crunch. Stock investors seem to agree. Financial stocks have fallen since the liquidity problems emerged, but they are roughly back to where they were in early 2012. However, the Shanghai composite index has fallen further, suggesting that investors fear slowing demand more than the credit crunch.

  The central bank is actually using monetary policy to deflate a credit bubble. Estimates of total credit in China vary, but one popular measure - the stock of non-goverment, non-financial debt as a share of GDP - rose above 200 percent in early 2013, a steady rise from 140 percent at the end of 2008. This rise in credit is funded partly by "wealth management products" investments that pay higher returns than the 3 percent deposit rate.

  These products are short term - many mature in under a month - and were originally designed to help property developers weather liquidity constraints, but their scope has expanded such that an estimated 40 percent of outstanding wealth management products were collateralized with non-standard assets in 2012.

  Non-standard assets

  These non-standard assets include stocks, copper futures, exporters' accounts receivables, and local government investment vehicles. According to China International Capital Corp, wealth management products totaled 7.1 trillion yuan (US$1.2 trillion) in 2012, which is higher than the 5.6 trillion yuan in central government revenue.

  But while there may be problems or excesses in credit markets, they are technically out of the purview of the central bank and should be dealt with by the China Banking Regulatory Commission, which has the power to enforce regulation over the shadow banking sector. Increased transparency and disclosure of risks would be better in fixing these excesses rather than tighter monetary policy, which is a blunt tool that will hurt unrelated businesses.

  Slowing growth, low inflation, a rising currency and rising bond yields all suggest that monetary policy is tightening.

  We believe that an implicit tightening of monetary policy is driving China's slowdown. The government has the ability to boost growth if it chooses.

  Reserve requirements are still close to record levels. Banks must keep around one fifth of their capital at the central bank. Lowering the reserve ratio, coupled with a crackdown on wealth management products, would ease liquidity constraints and signal that the government is focused on boosting growth and not reinflating the credit bubble.

   

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