The central bank is acting as a lender-of-last-resort for debt-strapped local governments struggling to sell new bonds on the open market
By Ambrose Evans-Pritchard in Washington
8:32PM BST 27 Apr 2015
A Chinese man walks past a billboard showing collage of Chinese Yuan and US dollars in Beijing Photo: AP
China is drafting plans for bond purchases to boost liquidity and shore up the country's $2.6 trillion edifice of local government debt, becoming last of the world's big economic powers to resort to quantitative easing.
The news propelled the Chinese stock market to a seven-year high on Monday, helped by fevered talk of a merger between Sinopec and PetroChina, the country's two oil giants..
The Shanghai Composite index of equities has risen by 40pc this year and 125pc since June, even as the economy grapples with a property slump.
Corporate profits fell 2.6pc in the first quarter and swathes of industry are mired in recession. "The operational situation of industrial enterprises remains grave," said the National Bureau of Statistics.
The People's Bank of China (PBOC) is looking at menu of unconventional measures to expand its balance sheet, according to officials cited by Market News. These include the option of buying $160bn of local government bonds from the banks.
While this is already being dubbed "China's QE", it may not add much stimulus and has an entirely different purpose from actions by the US Federal Reserve, the European Central Bank, or the Bank of Japan. The latter were attempting to drive down borrowing costs once short-term rates could drop no further. China is still a long way from the 'zero-bound'.
"It is only akin to QE in the sense that it involves asset purchases by the central bank," said Mark Williams from Capital Economics.
The PBOC appears to be stepping in to help local governments as they struggle to find market buyers under a new debt-swap regime, a reform pushed through earlier this year to clamp down on regional finances.
"It is acting as lender-of-last-resort for local governments. This is not a monetary policy measure, or part of broad monetary loosening. If they wanted to do that they would cut the reserve requirement ratio (RRR), which is 18.5pc and still very high," he said.
The PBOC slashed the RRR by 100 basis points earlier this month - the biggest cut since 2008 - but this was chiefly to offset monetary tightening caused by a surge of capital flight in March.
It is not stimulus as such but that has not stopped investors reacting with euphoria, stoking further excesses in a market already in the thrall of dangerous speculation.
A record 3.3 million people opened 'A-Share' accounts last week and joined the stampede. Margin debt has risen to a record 8pc of the free float on the stock exchange, evoking comparisons with the final blow-off on Wall Street in 1929.
"Financial logic dictates that asset prices cannot decouple from the growth of the global economy forever," said Mark Haefele from UBS. "Investments eventually need to be justified by profits. The assets on the receiving end of liquidity can change suddenly."
Ma Jun, the PBOC's chief economist, insists that the Chinese economy can weather the current slowdown for now without the need for major stimulus, citing healthy levels of job growth.
There is no doubt that the authorities are taking precautionary action to head off a very bumpy landing. Seven-day interbank lending rates have dropped by 200 basis points to under 3pc since the cash-crunch in March, a sign of easing.
Mr. Ma said the PBOC's measures were intended to offset "passive" monetary tightening occurring for other reasons. The country's slide into near-deflationary conditions has automatically pushed up real borrowing costs for Chinese companies by five percentage points since 2011.
The Chinese authorities still have enormous fire-power. They could cut the RRR all the way down to 5pc or even lower in extremis, injecting at least $2 trillion of credit into the financial system. But this would perpetuate the same corrosive 'on-off cycle' of ever-rising debt.
Total debt has reached 250pc of GDP, if all forms of trusts, shadow banking, and off-shore lending are included. "No country has ever survived that sort of rise without something bad happening," said Nariman Behravesh, global economist for IHS Global Insight.
Mr Behravesh said a financial crisis is unlikely since the Chinese state controls the banking system, but that alone cannot conjure away excesses on this scale. "What is more likely is a Japanese-style lost decade. The question is at what point they forget about reforms and just stimulate again and put off the day or reckoning because they can't bear the pain. We're not there yet but we are seeing a dramatic slowdown," he said.
President Xi Jinping seems determined to tough it out, opting to lance the boil of excess credit early in his 10-year term, and before it escapes control altogether. He has established such a tight grip on the Communist Party that he can probably withstand an economic squall.
Finance minister Lou Jiwei warned over the weekend that there is a 50pc likelihood that China will slide into the "middle-income trap" over the next five to ten years unless it curbs leverage.
The low-hanging fruit of easy catch-up development has already been exhausted.
Citigroup estimates that growth has dropped to 4.6pc over the last year, far below the official claims of 7pc. The Conference Board thinks the real figure is just 4pc.
Diana Choyleva at Lombard Street Research says GDP actually contracted by 0.2 in the first quarter, led by an ominous plunge in real domestic demand of 2.1pc. "Beijing has made a conscious policy choice to go for “creative destruction”, although we have yet to see the extent of corporate defaults," she said
"Sceptics of China’s ability to rebalance without a major crisis are right to worry, as the task is fraught with uncertainty. China has taken a huge gamble."
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