(Bloomberg) -- The unmistakable signal from U.S. Federal Reserve Chairman Jerome Powell that a rate cut is imminent hands China more room to maneuver in easing its own monetary policy. The question is on which tool to use.
With a slowing economy, resurgent deflationary fears and the downdraft from trade tensions, the case for easier policy from the People’s Bank of China is building. A more stable yuan also gives Governor Yi Gang and other policy makers more leeway.
“If the Fed does cut rates in July, it would open room for a domestic interest rate cut here,” Ming Ming, head of fixed-income research at Citic Securities Co. in Beijing wrote in a note. “China’s central bank will very likely follow suit.”
It’s not as simple as matching one rate cut in Washington with another in Beijing, though. China’s complex array of monetary tools is in flux, and the instrument that’s nominally still the “benchmark” is falling into disuse. Policy makers have given few clues about their intentions, and a meeting of the Politburo later this month may be the first opportunity to clarify the government’s intentions.
Here’s an analysis of different monetary easing venues:
Reverse Repurchase Rate
The interest rate the PBOC charges on 7-day reverse repo operations had been its most favored tool to mirror the Fed’s rate decisions in recent years. The central bank raised the cost of the short-term loans by 5 basis points in March 2018 after a Fed hike, but has kept the price unchanged since then. The rate is seen falling in the second half of the year, according to a Bloomberg survey of economists last month.
Whether such a market-centric cut is effective to lift sentiment and revive production is questionable, though. The PBOC faces renewed difficulties around the transmission of cheap funding to the real economy. Further lowering market borrowing costs aren’t likely to be very helpful without other measures to unclog the monetary plumbing.
Rate Reform
A recent State Council meeting presided over by Premier Li Keqiang pledged to lower “real” borrowing costs, indicating the easing will come from better transmission of monetary policy and lower loan application fees, rather than a direct interest rates reduction.
A long-postponed reform of interest rates to make borrowing costs more market-oriented is gathering pace. While details aren’t yet available yet about the revamp, policy makers are working to make interbank borrowing and bond yields more in line with the price charged for the PBOC’s short-term and mid-term loans.
The reform can “allow a better transmission of monetary policy, with the ultimate purpose of lowering corporate borrowing cost and reviving credit demand,” according to a report by Judy Zhang, an analyst at Citigroup (NYSE:C) Global Markets Ltd.
Reserve Ratios
Lowering the amount of money banks have to deposit at the central bank can provide cheap long-term funding to lenders and encourage credit growth. The ratio of required reserves is seen declining further this year, according to a Bloomberg survey of economists. Premier Li Keqiang also said this month that the government will offer cuts or targeted cuts for the reserve-requirement ratios aimed at specific sectors.
Medium-Term Lending Facility
The borrowing cost the PBOC charges for more expensive longer-maturity loans usually moves along with the rate for 7-day reverse repo operations, otherwise it’d give way to interest rate arbitrage. The overall amount borrowed via this facility has been declining, and with more reserve-ratio cuts on the way, that can help banks pay off those loans and replace them with cheaper options.
Benchmark Rate
China’s one-year lending rate, a tool that governs borrowing costs across the whole economy, is arguably the least likely to be used. Amid concerns about the fragile yuan, rising household debt as well as the risk of property and stock market bubbles, policy makers have shied away from adjusting this rate since 2015. The PBOC is on track to revamp the rates system this year, which may cause the so-called benchmark to be scrapped altogether.
To contact Bloomberg News staff for this story: Yinan Zhao in Beijing at yzhao300@bloomberg.net
To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net, James Mayger
©2019 Bloomberg L.P.