by Michael LoGalbo
Seemingly timid at first, the People’s Bank of China has stepped up its recent economic reforms. China’s central bankers have significantly loosened monetary policy in the hope of turning the country’s economic growth back toward their 7 percent target. Without further stimulus, it seems the world’s second largest economy could lead to financial contagion.
Chinese yuan (Image: Wikimedia Commons)
All eyes are on China as the People’s Bank of China (PBOC) continues to implement stimulative monetary policies following the recent global market sell-off. After the liquidity crisis in 2013 brought on by the economic boom of China’s 2008 stimulus program and shadow banking issues that resulted, the PBOC began playing a much more active role in the direction of the Chinese economy. Understanding the decision-making of the PBOC can give international observers insight into whether China’s economy will continue to stumble or return to the growth realized over the past decade.
Recent PBOC actions can be tracked to June 2014 when bank officials attempted to pre-empt a potential liquidity crisis. During the months that followed, the PBOC injected 500 billion yuan ($81 billion) into the country’s top five banks in the form of three-month, low-interest rate loans. The move sought to reduce concerns of expected liquidity tightening and a rise in short term interest rates, especially during a series of 10 initial public offerings on the domestic exchange in the remainder of the year. While small in scale, this effort by the PBOC showed that the strategy at hand was to implement targeted and focused changes before sweeping reforms.
In response to an increasing debt burden and dragging economy, the PBOC began implementing more traditional policy measures late last year. Beginning in November 2014, the PBOC cut its one-year benchmark interest rate 40 basis points to 5.6 percent. Seeking to further reduce borrowing costs for banks and large companies, the PBOC has persisted with this strategy, cutting interest rates four more times to 4.6 percent today (see graph below).
However, faced with persistent lackluster growth estimates, the PBOC recently implemented a major shift in expansive policy measures, proving that it is willing to make more extreme reforms to support an economic rebound. On August 11, 2015, the world’s second largest economy devalued its currency by 1.9 percent, the largest drop for the yuan in over two decades. PBOC officials now say they plan to bring their currency in line with the market, while they had previously ignored market signals and pegged the currency to where they saw fit. This news also comes after the release of weak economic data stating that Chinese exports fell 8.3 percent in July. A cheaper currency will allow China to maintain its competitiveness in the global markets. As visualized in the yuan to U.S. dollar chart below, the devalued yuan reduces the price of Chinese products, especially to U.S. buyers, stimulating demand for Chinese exports and driving economic growth.
Devaluing its currency is the latest in a string of PBOC monetary policy efforts. The central government, in addition to interest rate cuts and liquidity injections, has also been flexing its fiscal policy muscles. Since June 2015, the Finance Ministry has been playing a role in inflating China’s stock markets by ordering state agencies to purchase shares in the open market. Just recently, on September 7, 2015, the Ministry unveiled plans to further stimulate the economy by cutting taxes for small businesses and allocating 70 billion yuan ($11 billion) for two infrastructure railway projects.
Over the past fifteen months, the PBOC has proven that after attempting small changes it is willing to take monetary policy to great lengths in pursuit of economic recovery. It is possible the PBOC may consider additional options such as a reduction in the reserve requirement ratio, the minimum portion of a depositor’s balance required to be held in cash at a bank, or additional interest rate cuts. Nevertheless, continuing to track the trend of economic reforms implemented by the fiscal policies of the Chinese government, but more importantly by the monetary policies of the PBOC, will provide understanding of the current economic rout and perspective into the outlook of the Chinese central bankers.
Michael LoGalbo is the managing partner of Edgewood Court LLC, a consumer lending company. Previously, he was an asset management analyst at Mount Kellett Capital Management where, amongst other responsibilities, he authored and maintained a comprehensive, weekly, macroeconomic report and commentary designed to generate new investment ideas and enhance the management of current portfolio assets. Michael is passionate about the field of study where geopolitics meets macroeconomics.
The opinions expressed in this article are the author's own and do not reflect the views of their employer or Young Professionals in Foreign Policy.