Andrew Sheng and Geng Wiao write: The People’s Bank of China has cut interest rates for the third time in six months, in order to lighten the debt burdens of companies and local governments. But the PBOC’s monetary easing – accompanied by complementary fiscal and administrative adjustments – has done little to increase demand for new loans. Instead, it has triggered a sharp rise in China’s stock markets. The question now is whether that could turn out to be a very good thing.
There is little doubt that China’s economy is shifting gears very quickly. Official statistics show a slowdown in real growth in the old manufacturing and construction-based economy, reflected in declining corporate profits, rising defaults, and an increase in non-performing loans in poorer-performing cities and regions.
With harder budget constraints imposed by the central government, local officials and state-owned enterprises (SOEs) have curbed their spending which could lead to localized balance-sheet recessions.
Increased innovation and the rise of the services sector have helped China move beyond its role as the world’s factory to develop its own version of the Internet of Things, driven by platform companies like Alibaba and Tencent.
Some 14.3 million new stock-market trading accounts were opened in China last year. The revival of China’s stock market in a low-interest-rate environment represents an important shift in asset allocation away from real estate and deposits. Roughly 50% of Chinese savings – amounting to as much as half of GDP – lie in real estate alone, with 20% in deposits, 11% in stocks, and 12% in bonds.
Rising stock-market capitalization also helps to reduce the real economy’s exposure to bank financing. The US is much more “financialized” than China, with stocks and bonds amounting to 133% and 205% of GDP, respectively, at the end of 2013. Those ratios were only 35% and 43%, respectively, in China.
But the rapid run-up in equity prices also carries considerable risks – namely, the possibility that the financial sector will misuse the newfound liquidity to finance more speculative investment in asset bubbles, while supporting old industries with excess capacity.
Even if Chinese retail investors begin to channel their money toward innovative ventures, identifying the companies and industries most likely to succeed will be difficult.
As China’s animal spirits are channeled, they will increasingly test the authorities’ resolve to resist price intervention, instead allowing market forces to propel the business cycle.
Indeed, at the end of last year, China still had CN¥22.7 trillion of statutory reserves, amounting to 36% of GDP, that had long been used to “sterilize” its large foreign-exchange holdings.
