The People's Bank of China (PBOC) is expected to implement the largest monetary stimulus in years to revive the economy.
Reuters said that this may be the central bank's most aggressive monetary strategy in a decade, aiming to stimulate the economy and mitigate the economic impact. Tariff increases implemented by the Trump administration. But the outcome is far from certain.
The People's Bank of China announced on Friday that it would suspend purchases of government bonds due to asset scarcity, underscoring the limits of its resources in the face of an increasingly challenging economic environment.
See also: Biden's last ditch effort: Limits on U.S.-made AI chips, Russia sanctions
Analysts say policy implementation is complicated by multiple factors. There are risks of currency and capital outflows, weak domestic credit demand and shrinking room to cut interest rates and inject liquidity through lower reserve requirements (the amount of cash banks need to hold in case of emergencies).
These limitations are interrelated. Further bond purchases, interest rate cuts or liquidity injections could put depreciation pressure on the yuan, potentially causing funds needed for domestic growth to flow overseas.
Even before the bond-buying pause, the limits were apparent.
In a rare forward-looking speech in September, Pan Gongsheng, governor of the People's Bank of China, said that the reserve requirement ratio may be lowered again before the end of the year based on market conditions. However, despite the loose policy stance, the RRR cut did not occur.
More monetary easing may support the economy in the short term but fuel asset bubbles in the long term.
China’s central bank has repeatedly warned that rising bond yields, which have pushed yields to record lows, could undermine financial stability when markets turn.
“Short-term versus long-term, internal versus external, exchange rates versus interest rates – these are multiple conflicts,” said Xing Zhaopeng, senior China strategist at ANZ Bank.
face deflationary pressure Coupled with growing headwinds to already-struggling economic growth, China's top leaders abandoned a 14-year-old “prudent” monetary policy stance in December and instead adopted a “moderately loose” stance.
RRR cut expected this month
But analysts say the scope for cutting interest rates and bank reserve requirements is smaller than the scale of easing in the “sound” era, meaning the central bank may have to be more prudent in practice than before.
The People's Bank of China's 7-day reverse repurchase rate is the new benchmark policy rate since last year. After a total reduction of 30 basis points in 2024, it is currently 1.5%.
“Theoretically, the lower bound for interest rates is zero, as is the case in the United States and Japan. However, I don't think interest rates in China will go to zero,” said Larry Hu, chief China economist at Macquarie.
Hu Jintao predicts that the policy rate will be cut by 40 basis points, which will still be the largest annual rate cut since 2015.
“If credit demand does not pick up, further interest rate cuts may not lead to an increase in loans, but may instead create financial market bubbles,” Hu said, adding that it would also hurt bank profitability and increase capital outflows due to excessive currency depreciation. risks and dampen confidence in the economy.
Business confidence is low and consumer confidence is near historic lows. Bank net interest margins, a key measure of loan profitability, fell to a record low of 1.53% in the third quarter of 2024.
Still, most analysts expect a reserve requirement ratio cut this month, with the weighted average rate accumulating up to 100 basis points from 6.6% throughout 2025. That would bring average reserve requirements closer to the 5% threshold – currently a requirement for the smallest banks and widely seen as a minimum.
Concerns about RMB depreciation
The shrinking space for interest rate cuts and reserve requirement ratio cuts may also hinder the central bank's reforms.
The People's Bank of China's stated goal of relying less on banks' “quantitative” approach to expanding credit and relying more on interest rates for policy transmission, allowing the market to play a more prominent role in financing the economy, is becoming increasingly difficult. .
“Moderately loose monetary policy will involve interest rates and quantitative measures,” said Xu Hongcai, deputy director of the Economic Policy Committee of the China Policy Science Association.
Xu also forecast a 40 basis point rate cut, warning that the pace of easing needs to be balanced with currency concerns.
“Excessive currency depreciation may destabilize financial markets, affect expectations and trigger panic,” Xu said.
Some analysts, including Hu and Xing, believe the suspension of government bond purchases shows China's central bank is uneasy about the damaging effects of a rapid depreciation of the yuan.
But not all economists are so worried about currency weakness. In theory, it could make exports more competitive and lessen the impact of U.S. tariffs, which incoming President Donald Trump has threatened to raise to 60% on all Chinese goods.
Zhang Ming, a senior economist at the Chinese Academy of Social Sciences think tank, published an article on his WeChat account on January 2, saying, “Sacrificing monetary policy flexibility to maintain exchange rate stability is tantamount to putting the cart before the horse.”
He said the exchange rate was likely to appreciate rather than depreciate if interest rate cuts boosted growth.
- Reuters Additional editing by Jim Pollard
See also:
China faces deflation risk as weak demand affects consumer prices
Trump may declare national economic crisis over new tariffs: CNN
China's top automakers continue electric vehicle price war for third year in a row
China plans to issue record $411 billion in bonds in 2025: sources
Trump plans to restrict China's electric vehicle supply chain
China to take on more debt in response to Trump tariffs
China's central bank 'allows yuan to depreciate' as trade risk
Chinese media on Trump: “There are no winners in the tariff war”
China 'keen to negotiate trade deal to reduce tariff threat'
