China’s economy is clearly looking at a volatile future

In contrast, the People’s Bank of China (PBOC) began easing monetary policy from around April this year after being in line for a long time in the early stages of COVID-19. M2, the broadest measure of the money supply, has been expanding in China at about 12% year-on-year and is now outpacing credit growth, which is about 10% year-on-year. Meanwhile, economic growth has not reacted in the wake of continued lockdown. In economics speak, these are early signs that China’s money supply has begun to “push on a string” and that further stimulus could come from fiscal policy.

The size of the PBOC’s balance sheet is approximately 38 trillion Chinese yuan (CNY) or about $5.6 trillion (62% of the size of the US Fed). The PBOC balance sheet, which has been on constant expansion over the years, has qualitatively changed its outlook in 2016. Until then, the expansion was in lock-step development with the rise in China’s current account and foreign exchange reserves. Since 2016, the PBoC balance sheet has grown by lending to the country’s banking system. China’s foreign exchange reserves were at a peak of about $4 trillion at that time and have declined by nearly $1 trillion. At the same time, the Chinese current account surplus has declined from an average of 3-4% of gross domestic product (GDP) before 2016 to less than 2% now, so structurally it appears that the pace of currency reserve accumulation will continue to drop. For.

In other words, China’s economy is gradually becoming less international and more domestic. As it happens, policymakers in China are beginning to feel that their tools for domestic macro-economic management, both monetary and fiscal, are not sufficiently diverse and well-tested. China’s policy for domestic expansion has been to encourage its real estate sector. True, in the summer 33 new measures were introduced to strengthen this sector. However, these measures contradict a pillar of the ‘Xi Jinping idea’, which is to decongest and clean up the real estate sector, an activity that has been going on for some time. Therefore, despite these stimulus measures, China’s residential sector declined 28% year-on-year in July. Meanwhile, Chinese retail sales for the first half of the year have slowed to around 3%, the slowest for 30 years, apart from the directly COVID-affected quarters of 2021 and 2022. At the same time, despite slowing economic growth, inflation in China has been rising gradually and clocked 2.7% in July. The CNY has declined by around 10% since the beginning of this year and is one of the channels through which inflation is being imported into the country.

It seems likely that China will pursue both monetary and fiscal easing in an effort to lift itself out of the economic quagmire. The country would be doing this at a time when inflationary pressures are not benign. Before the pandemic, China has generally been careful to keep its fiscal balance within a narrow range as a ratio of GDP. The pandemic, its growing population and its trade war with the US have begun to put pressure on China’s ability to use fiscal policy very aggressively. Local governments have faced revenue shortfalls, which necessitated increased federal transfers. The sale of land-use rights is a plug, but has been disappointing due to the simultaneous tightening of regulations in the real estate sector. In an unsuccessful attempt, an increase in the property tax has been proposed in some jurisdictions, but the drug may be worse than the disease and has therefore been postponed.

China has already cut taxes for corporates and individuals. Even though China categorically denies that there will be “more borrowing from the future”, it seems that China may be forced to follow the 2020 US by income transfers in a desperate attempt to stimulate retail spending. At least, it will have to be done in some form to ensure that property buyers gain confidence in a system that now appears to be completely broken.

For the rest of the world, it adds another element to the unprecedented global situation. Developed markets and some emerging markets (including India) are tightening policy at the same time that China is easing up. If much of that easing is transmitted through a lower currency value, it would have the real effect of a competitive devaluation by China, and other exporting economies to suffer the consequences. If China keeps its currency relatively stable from here, with no tested domestic transmission mechanism, it risks stagflation.

Slow growth amid rising inflation in China, shrinking current account surpluses and depleting foreign exchange reserves is not a scenario the rest of the world has become accustomed to for at least three decades. The ability of Chinese macro-economic management is being tested. Early signs, unsurprisingly, suggest that it is moving against irreversible contradictions and decreasing.

PS “A flame that burns twice as fast burns half as long,” said the Chinese philosopher Lao Tzu.

Narayana Ramachandran is the chairman of Include Labs. Read Narayan’s mint column at www.livemint.com/avisiblehand

first article